What Is the IRS Interest Rate for Payment Plans?
The interest rate the IRS applies to unpaid taxes is the short-term rate plus 3 points.
Interest accrues on your account any time you have an unpaid balance, and this includes if you’re making payments through a payment plan. To get help now, contact us at the W Tax Group today.
How Much Is Interest on IRS Payment Plans?
If you set up a monthly payment plan on your tax debt, the IRS will assess interest on your account. As of April 2023, the interest rate on payment plans is 7%. This is the federal fund’s rate of 4.33% from January plus 3%, rounded to the nearest whole number.
It was the same rate during the first quarter of 2023. However, during that quarter, the rate was based on October’s fed rate of 3.08%. Again, you simply add three points and round to the nearest whole number to get the rate.
Over the years, the rate has fluctuated between a low of 3% and a high of 22%. That was based on a fed funds rate of 0% and 19% respectively.
How Does the IRS Calculate Interest on Unpaid Taxes?
The IRS adjusts the rate quarterly based on the federal funds rate in the first month of the previous quarter. For instance, the IRS interest rate in the first quarter of the year is based on the fed rate from October of the previous year. The interest for the second quarter of the year is based on the federal funds rate from January of the previous year.
Annual Interest Based on Amount Due
The IRS interest rate compounds daily. That means that interest is assessed to your account daily, and then, the next day, more interest compounds on the interest that has accrued. This cycle continues until you pay off the debt in full.
Here is the annual interest that will accrue on your account based on the IRS’s current interest rate of 7%. Note this rate was current during the second quarter of 2023. It is very subject to change.
- If you owe $10,000, the annual interest will be $725.01.
- If you owe $50,000, the annual interest will be $3,625.05.
- If you owe $100,000, the annual interest will be $7,250.10.
- If you owe $250,000, the annual interest will be $18,125.25.
If the rate falls lower than 7%, the annual interest will be lower. If the rate goes higher, the interest will be higher. Also, keep in mind that as you make payments, you will reduce the principal, and thus, you will pay less in interest.
When Does Interest Start Accruing on Tax Debts?
The IRS assesses interest on your account the very first day that you are late. Interest continues to accrue until you have paid off the balance. Even if you set up a payment plan, interest will continue to accrue on your account.
However, the IRS doesn’t just charge you interest for unpaid taxes. If you overpay the IRS, you will also earn interest on the overpayment. To give you an example, imagine you file a tax return and you pay the amount due. Then, a year later, you amend your return and you get a $1,000 refund.
The IRS will pay you interest on the refund. The interest starts the day that the return was due or filed, and it continues until the IRS sends you the $1,000 refund plus interest.
Interest Rate for Corporate Vs. Individual Taxes
For individual income tax, the IRS uses the fed rate plus three percent. That applies both to underpayments and overpayments as explained above.
If a corporation makes an overpayment, the rate is the fed rate plus 2%, and it drops to the fed rate plus 0.5% for overpayments over $10,000. If a corporation has a large underpayment, the interest rate is the federal rate plus 5%. Generally, the IRS will only accept payment plans over a certain threshold if the entity is out of business but this means that if you set up installment payments on a large corporate debt, your interest rate is likely to be 2 points higher than it would be for a payment plan on individual income tax.
Other Costs for an Installment Agreement
The interest rate is not the only cost you’ll incur when you set up a payment plan on your back taxes. The failure-to-pay penalty will continue to accrue on your account. This fee starts at 0.5% of the balance per month, and sometimes the IRS increases it to 1% of the balance. It drops to 0.25% of the balance while you’re making payments.
You will also need to pay the following fees to set up your payment plan:
- Direct debit payment plan set up online: $31
- Direct debit payment plan set up with paper application: $107
- Payment plan without direct debit set up online: $149
- Payment plan without direct debit set up with paper application: $225.
- Payment plan with payments made directly from your paycheck: $225.
- Low-income taxpayers paying with direct debit: $43 (can be reimbursed when you complete the plan).
- Low-income taxpayers paying with direct debit: $0
- Making changes to your installment agreement on paper: $89
- Making changes on paper if you’re a low-income taxpayer: $43
- Making changes to an installment agreement online: $10
You will also incur additional fees if you pay by credit or debit card. Debit card fees are usually $2.20 to $2.50 per transaction. Credit card fees are between 1.85 and 2.98% of the payment with a minimum fee of $2.500 and $2.69. These fees are current as of April 2023. For current rates, check out the IRS website.
How to Calculate Your Monthly Payment With Interest
When you apply for a payment plan, the application prompts you to calculate your minimum monthly payment by dividing your total balance by 72. That shows you how much you need to pay so that you pay off your debt in six years. If the collection statute expires sooner, you will need to adjust this number accordingly. For instance, if your debt expires in three years, you will divide the total balance by 36.
If you want to account for interest, you should calculate the annual interest on your account. Then, divide this number by 12 and add that to your monthly payment. For instance, if you owe $10,000, your annual interest will be $700 based on a 7% interest rate. If you divide that by 12, you get $58.33. If you add this amount to your monthly payment, you can be sure that your payment covers the interest.
Note that this is just an estimation of the interest cost. The interest will actually be lower than this amount because every time you make a payment, you reduce the principal which reduces the interest. However, this is an easy calculation you can do to ensure that you cover the interest with your monthly payment.
How to Reduce Penalties and Interest
Setting up a payment plan helps to minimize the penalties on your account. As indicated above, your failure to pay penalty will drop to 0.25% per month once you set up a payment plan.
Additionally, you can ask to have the penalties abated. The IRS will typically agree to remove your penalties if this is the first time you have incurred penalties or if reasons out of your control caused you to pay or file late. This includes things like death, illness, and natural disaster. If the IRS removes penalties, it should also remove the interest that accrued on the penalties.
Unfortunately, other than that, the IRS won’t remove interest from your account. Generally, the only way to get interest removed is to prove that you paid or filed late due to receiving incorrect written advice from the IRS. Keep your correspondence to make sure you have proof to back up these types of claims.
Alternatives to IRS Payment Plans
If you have good credit, you may be able to get a loan to pay off your tax debt. If the loan has a lower interest rate than an IRS installment agreement, you will save money in the long run. Alternatively, you can use a credit card to pay off your tax debt, but if the interest rate is higher, you will end up spending more in the long run.
However, a higher interest rate is worth it for some people. If you pay off your tax debt, you don’t have to worry about the IRS issuing a federal tax lien. In a lot of cases, the agency will issue a tax lien even if you set up a payment plan.
Get Help Dealing With the IRS
Unfortunately, interest will accrue on your account anytime that you owe the IRS money, and the interest will even accrue if you have a payment plan.
However, by making payments on your account, you will be able to minimize the total amount of interest you pay. Depending on your situation, you may even be able to use an option such as an offer in compromise to reduce the principal on your tax debt.
Don’t let IRS tax debt stress you out. We can help you make arrangements with the IRS or your state tax agency. When you reach out to our tax attorneys, we’ll start with a free conversation about your situation. Then, we’ll help you identify the best resolution options for your situation. To get help, contact us today.