IRS Interest Rates: What Taxpayers Need to Know

Staff Writer - Angela
October 24, 2018

  • An interest rate is charged on past-due IRS debt, including both balances and penalties. The interest rate is tied to rates set by the Federal Reserve.
  • The current rate for individuals is 5%, which is compounded daily and assessed quarterly. Rates are likely to increase in 2019.
  • The only way to avoid paying interest on your IRS debt is to pay taxes when they are due. Avoiding penalties can minimize the amount of interest assessed.

IRS interest rates increased as of April 1, 2018. If you are making installment payments on a past-due tax balance, these new rates were assessed on a quarterly basis, beginning the second quarter of this year.

What Are the New Interest Rates?

IRS interest rates are tied to the Federal Reserve interest rates, which have also increased over the past several years. The IRS uses the Reserve’s short-term interest rates rounded to the nearest percentage point, plus 2 percentage points for corporate taxpayers and 3 percentage rates for noncorporate taxpayers. The updated interest rates are as follows:

  • 4% for corporate overpayments (2.5% of any balance portion exceeding $10,000)
  • 5% for individual overpayments
  • 5% for individual underpayments
  • 7% for corporate underpayments.

These rates compound daily and are assessed quarterly. According to the Motley Fool, an individual tax debt of $10,000 will accrue a daily interest of $1.37 until it is paid. If it takes you a year to pay the debt, you will ultimately pay the IRS $10,500.05. Underpayment rates, which are updated each quarter, are published by the IRS.

IRS Interest Rates: What Taxpayers Need to Know

Since the April 2018 increase, IRS interest rates have remained the same through the fourth quarter of 2018. In November 2018, the Federal Reserve announced that the current benchmark interest rate of 2% would be increased to 2.25% for the upcoming quarter. An increase in IRS interest rates for 2019 is likely to follow.

What Are the Federal Reserve Interest Rates?

The Federal Reserve is the central bank of the United States. Since 1977, this bank has been responsible for establishing market conditions that create jobs and keep consumer prices stable as dictated by Congress. When interest rates are increased by the Reserve, it is seen as a show of confidence in the U.S. economy.

The Federal Reserve interest rates determine not only IRS interest rates but also the rates consumers receive for mortgage loans, credit cards, and other types of funding. CNN Business reported that two more rate increases are expected in 2019, which will bring rates up to 3%, and at least one increase in 2020 to bring rates to 3.5%.

Although customers receive a higher interest rate on savings when the federal rate increases, they will also pay more for financing and for IRS penalties where applicable. If you can afford to pay off your IRS debt, it makes sense to do so as soon as possible, before new rate increases take effect. It also makes sense to pay off credit card bills. Those in the market for a new car or a new home may want to act sooner rather than later to take advantage of lower rates.

What Other Fees and Penalties Are Charged?

The interest rate on past-due taxes is assessed in addition to penalties for late payments. These include:

  • 0.5% per month for every month the tax is past due, up to a maximum 25% penalty. This increases to 1% per month if you receive a notice of intent to levy property from the IRS and don’t make a payment within 10 days.
  • 5% per month for every month you fail to file your tax return, up to a maximum 25% penalty.
  • 0.25% per month for those who file taxes on time and have requested an installment agreement, for each month that the agreement is in effect.

If you owe taxes and have not filed your return, you will only be charged the 5% monthly penalty, not 5.5%. If you have not filed your taxes but do not owe any money to the IRS for the return in question, you will not be penalized.

Late filing also carries a minimum penalty of either $200 or 100% of the past-due tax balance (whichever amount is less).

Although filing an extension gives you an additional six months to file your tax return, interest will continue to accrue during this time. However, you will not be charged penalties during this grace period.

If you can prove your failure to file or pay your return has a reasonable explanation, the IRS may agree to waive penalties. You’ll still be responsible for the interest, however.

You may not be penalized for a tax underpayment if:

  • The underpaid amount is less than $1,000
  • You did not owe taxes or received a refund last year
  • The underpaid amount is less than 10% of what you owe
  • You are retired
  • You are disabled
  • You are subject to other special circumstances, such as a natural disaster or a hurricane.

How Can I Avoid IRS Interest and Penalties?

When you get hired for a new job, your employer will require you to fill out IRS Form W-4. This information is used to determine the correct amount of withholdings. When you file your annual tax return, if the amount withheld exceeds your calculated tax liability, you’ll receive a refund from the IRS.

On the other hand, if the taxes withheld from your checks are insufficient to cover your tax liability, you’ll have to pay the balance. If you are unable to do so by the deadline, you will be required to pay penalties and interest as a percentage of the past-due balance amount.

If you are a freelancer, you must make estimated quarterly tax payments, which are typically based on the taxes assessed for the previous year. Failing to make these payments can also result in underpayment.

Assessing your tax liability before it is due is the best way to avoid underpaying the IRS. You can also submit a new W-4 to your employer to increase the amount of your withholdings, which may result in a refund when you file your tax return. Use the IRS withholdings calculator to determine the correct percentage of your salary to withhold.

When you do pay your taxes, make sure your payments are properly credited to avoid erroneous interest and penalties. The most convenient and straightforward way to do this is by simply using the IRS Electronic Payment system, which allows you to apply your payment to a specific balance.

If you opt to send a payment through the mail, be sure to take the following steps for proper payment credit:

  • Tear off the stub provided at the bottom of your bill and send it along with your payment.
  • Use the IRS-provided envelope that accompanied your bill.
  • Send a check or money order made payable to the United States Treasury.
  • Write your tax identification number (either a Social Security number or employer identification number) on the payment stub and on the check or money order.
  • Write the tax year and form number on the check or money order. This is provided on the bill.
  • Write your name, address, and phone number of the payment stub and the check or money order.
  • Use the correct amount of postage.
  • Do not send cash. If you want to pay your taxes in cash, you can do so at participating retail locations. Look for payment sites near you on the IRS-approved Official Payments website.

Keep in mind that when you make a payment toward your tax debt, the money will first be applied to the past-due tax, then to penalties, and then to interest.

Will the IRS Waive Interest and Penalties?

If you can show that you missed your tax filing or payment deadline with reasonable cause, and willful neglect is not present, the IRS may agree to waive certain charges. However, this usually applies only to penalties and not to interest. To request a waiver of penalties, you can visit your local IRS service center along with the bill and your explanation for the missed deadline, or you can call 800-829-1040.

In addition, the regular deadlines may not apply to your tax return and payment if you are a member of the Armed Forces currently serving in a contingency operation or combat, if you are a U.S. citizen working abroad, or if you were involved in a natural disaster. Even in these cases, you must review your IRS notices and bills and follow the instructions provided or ask for assistance when needed.

In general, you must pay past-due tax, interest, and penalties in full before requesting a waiver of penalties (which will then be granted as a refund).

How Will the Tax Cuts and Jobs Act Affect Interest and Penalties?

Because the new Tax Code and Jobs Act adjusted withholding tables to provide employees with more take-home pay, some individuals may find they owe more than expected at tax time. For this reason, President Trump requested in November 2018 that the IRS waive underpayment penalties for these taxpayers.

This is most likely to impact working married couples with no children or whose children are older than 17, those from states with high taxes that have limited state and local deductions to $10,000, and those with substantial expenses that are no longer reimbursable. The latter category includes employment costs such as continuing education and mileage, estate planning expenses, and financial and tax advisory costs.

What Happens When I Have a Tax Underpayment?

If you have underpaid your taxes, the IRS will send you Form 2210, which compares the total amount you owe to the amount withheld from your paychecks.

To avoid an underpayment, check your withholdings to make sure your employer is taking enough taxes out of your paycheck to meet your quarterly taxes. If this amount doesn’t meet your tax obligations, you will receive a smaller refund or may owe more taxes than expected.

If you previously itemized deductions and will no longer do so under the Tax Cuts and Jobs Act, you may want to increase your withholdings. This also holds true for taxpayers who have dependents. If you are retired, you can arrange to have your taxes withheld from your pension or Social Security payment. Although it is too late for your withholdings updates to impact 2018, if you owe, you can make the adjustment for 2019.

What Happens If I Overpay My Taxes?

When your withheld taxes exceed your tax liability, the IRS will send you a refund. If this is not received within 45 days of the tax deadline for that year, you may be eligible for 5% interest. This means if your refund is $500, the IRS will send you $525 if the refund is late.

The IRS may also pay interest if they assess and amend your return for a higher tax amount in error.

What If I Can’t Afford to Pay What I Owe the IRS?

If your tax bill is higher than you can afford to pay, you do have options. Paying as much as possible as soon as possible can help you minimize interest and penalties. Other steps you can take include:

  • If you think you’ll be able to pay the past-due amount within 120 days, you can file for an extension at no additional cost.
  • You can also apply for an installment agreement if you owe less than $50,000. File Form 9465 to request a monthly payment plan.
  • If you have a financial hardship and cannot pay your tax bill, you may qualify for an Offer in Compromise. With this route, the IRS agrees to settle your tax debt for only a small percentage of what you owe. You must meet certain eligibility requirements, however.

Because failure to file penalties is much more expensive than failure to pay penalties, it’s important to file your taxes even if you don’t think you’ll be able to pay what you owe. The IRS will attempt to collect your unpaid tax debt even if you don’t file a return. In extreme cases, a federal tax lien can be placed on your house, car, or other property. This means the IRS has a legal claim to your property until the taxes are paid in full. Liens can also be levied against bank accounts and future wages.

Solvable can help find a solution to your tax debt. Fill out our basic questionnaire to get matched with vetted businesses that will negotiate on your behalf. We also assist customers who are unable to pay their credit card or student loan debt.

 

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