Interest Rates on IRS Installment Agreements
When you’re unable to pay your taxes in full by the due date, you have options. Setting up an installment agreement allows you to avoid outcomes like levies or liens while keeping you compliant with IRS requirements. There are certain fees and additional expenses associated with installment agreements, including interest on the unpaid amount owed.
Understanding interest rates, additional fees and penalties, and other costs that come with installment agreements can help you make an informed decision regarding your current tax bill, but at the end of the day, requesting an installment agreement is pretty straightforward. However, if the scope of your tax problems goes beyond what a simple installment agreement can cover, it’s a good time to talk to a tax professional about your options. Browse tax professionals near you with TaxCure’s database of licensed, vetted tax experts.
An Overview of Installment Agreements
The IRS offers payment plans, known as installment agreements, for taxpayers who cannot pay their taxes in full. Taxpayers may either pay with automatic direct debit, checking or savings accounts, checks, money orders, or credit/debit cards.
Installment agreements last longer than 180 days; anything 180 days or less is considered a short-term payment plan. You can apply online if you owe $50,000 or less and have filed all required tax returns. When you apply online, the IRS notifies you automatically whether your application is accepted or denied. Once your installment agreement is approved, you can change your due date online, change to a different payment method, or reinstate your agreement after missing a payment.
As long as you make your monthly payments on time, you remain in good standing with the IRS. Note that you must continue filing tax returns and paying taxes owed for subsequent tax years in order to remain in good standing. If you are unable to do so, you may be able to adjust your current payment plan to include additional taxes owed from later years. The installment agreement will remain in effect until your past-due taxes, interest, and penalties are paid in full.
Interest Rates for Unpaid Taxes
The IRS charges interest on unpaid taxes, and the rates are different for individuals and corporations. Interest rates are revisited and updated quarterly.
Generally, the interest rate charged by the IRS is the federal short-term rate plus three percentage points. This interest rate is the same for corporations with small underpayments. Corporations with large underpayments generally pay the federal short-term rate plus five percentage points. The IRS Newsroom has the most current interest rate listings.
2024 Interest Rates Charged by IRS
For the first quarter of 2024, the IRS charges 8% per year for individual underpayments and corporations with small underpayments. Large corporate underpayments accrue interest at a rate of 10% per year. If you are reading this later than the first quarter of 2024, visit the Newsroom for current interest rates.
How Interest Affects Your Tax Debt Balance
Knowing when the IRS begins charging interest and how that interest adds up over time can help you figure out the best option for you as you move forward. The IRS begins charging interest rates from the date that the taxes are due in full—that is usually April 15 but may be the next business day if April 15 falls on a weekend or holiday.
Here's how the interest affects your balance due. Imagine your tax return says you owe $3,000, but you are unable to pay in full so you request an installment agreement. The minimum monthly payment is generally your balance divided by 72. This means that your payments will be spread out over six years. This initial amount due per month is $41.66 per month.
Assuming an interest rate of 8% based on the first quarter of 2024, the initial daily interest is $0.66. That is added to the $3,000 for the next day’s calculation, resulting in a bill of just over $3,001.
By the end of the first month, you will owe about $3,020. When you subtract your estimated payment of $52.64, your total due drops to about $2,967, and the following month, the interest accrues on that amount. By the time you have made 72 payments, you will have paid back almost $3,790—almost $800 in interest.
One more example: you owe $10,000. Your monthly payments come out to about $175.46 per month. After making 72 payments, you have paid over $2,600 in interest.
You also have to remember that during those six years, you will still need to file tax returns and pay whatever taxes you owe from those returns. If you do not adjust your withholdings so that you don’t owe more at the end of each tax season, you will owe more or have to roll over what you owe into your current payment plan. This will significantly increase the amount of interest you pay and the size of your monthly payments.
If you look back at interest rates over time, you’ll see that they vary quite a bit. That can make a significant difference in your monthly payments and total interest paid. For example, consider 2020, a time at which the federal rate was incredibly low. During quarters three and four, underpayments accrued interest at a rate of 3%. That amount would save a taxpayer owing $3,000 over $500 over the course of 72 payments. For a taxpayer owing $10,000, an interest rate of 3% would save about $1,700 in interest.
Beyond Interest: Other Costs of Installment Agreements
There’s more to an IRS installment agreement than just interest. First, don’t forget the late payment penalty (aka the failure-to-pay penalty). In addition to interest, the IRS charges an additional penalty until your back taxes are paid in full. This is equivalent to 0.5% of the total due for each month that the balance remains unpaid, up to a total of 25% of the total amount due. This fee increases to 1% per month after a certain period of delinquency.
That amount drops to 0.25% once there is an installment agreement in place. For example, if you owe $20,000, the late payment penalty starts at $100 per month (0.5%). Then, it increases to $200 per month (1%). But if you set up payments, it's only $50 per month (.25%).
There are also set-up fees. The fees you pay depend on which type of payment option you pursue. If you agree to automatic debit payments and apply online, the setup fee is $31. If you choose this option but apply by mail, phone, or in person, the fee is $107. If you do not opt for automatic payments, the online setup fee is $130. The fee to set up your plan over the phone, in person, or via mail is $225.
Certain individuals are entitled to a waiver or reimbursement of this fee. Taxpayers who make at or below 250% of the federal poverty level for their family size can request to have their user fee waived. This generally happens automatically if the IRS detects that you fall within these parameters, but if it does not, you can fill out Form 13844: Application for Reduced User Fee for Installment Agreements.
Is Interest Abatement an Option? Can Interest Be Eliminated?
Interest abatement may be an option if the IRS makes an unreasonable error or delay that results in you accruing additional interest. You can request this on Form 843: Claim for Refund and Request for Abatement.
Normally, however, the only way to completely avoid paying interest on your taxes is to pay the full amount by the time it is due. That said, you may be able to reduce the amount of interest you owe if you amend your tax return in a way that shows you owe less in taxes.
The IRS will then automatically reduce the interest based on your new payment due, and the agency will remove any interest related to taxes that you no longer owe. Additionally, if you qualify for penalty abatement, the IRS will decrease your interest based on the amount of penalties taken off your bill.
Effectively, interest may be eliminated if you opt for a Partial Payment Installment Agreement, known as a PPIA. This is an option for taxpayers who cannot pay the full amount due by the time the statute of limitations expires. A PPIA allows taxpayers to avoid levies, liens, and seizures while paying what they can on their overdue taxes. At the end of the collection period—generally ten years—the remaining amount owed falls off. This does decrease what you pay in interest, but you must also meet strict income requirements provided by the IRS to qualify.
Alternatives to Installment Agreements
If you want to avoid the interest on an installment agreement, you may need to look into alternatives. While an IRS installment agreement is often the best option for most taxpayers, it is definitely not your only option. If you have strong credit, you may be able to take out a personal loan.
Alternatively, you may want to use a credit card to pay your tax bill in full and then make payments on your credit card. Note, though, that it is very unlikely—almost unseen—for a credit card to have a lower interest rate than the IRS (unless it's an introductory rate). The high-interest rates that come with credit cards, often in excess of 15%, generally cancel out any points or rewards you get from using the card if you carry a balance.
If you have friends or family that can help you out, that is often the best option. It allows you to avoid interest and penalties. However, many people dislike knowing that they owe loved ones money. Still, it’s an option to look into.
As a general rule, the IRS installment agreement is the one that costs the least money over time. Some people prefer not to owe the IRS money or deal with the stress of an installment agreement, and so they look into options like those listed here.
Creating an Affordable Installment Agreement
When you request an installment agreement, you must provide the amount you owe and any other balances you owe that aren’t included. This includes anything currently part of an installment agreement. You can make a lump sum payment to reduce the total amount owed.
From there, you divide the amount you owe by 72. Per the IRS, this is the minimum you can pay. However, this may not be what you actually want to pay—the longer your payment plan is, the more you pay in interest and penalties. If possible, try to pay more than the monthly minimum so that you pay off the balance faster and reduce the total interest you have to pay.
Look over your monthly budget to figure out if you can increase your monthly payment at all. You want to strike a balance between paying off your taxes as soon as possible and paying the lowest amount you can per month. If the amount required for a 72-month payment plan is completely out of your budget, it may be time to contact the IRS about a PPIA or an offer in compromise.
FAQs on Installment Agreement Interest
What does daily compounded interest mean for my payments?
Daily compounded interest leads to the fastest accumulation of interest on your debt. Since interest is calculated daily and rolled into your existing debt, future interest calculations are based on a larger amount. This is why it’s so important to pay what you can on an IRS installment agreement, rather than settling for the lowest payment offered.
How often is the interest rate adjusted?
The IRS interest rate is adjusted every three months in line with federal short-term rates. Federal rates change based on signs of inflation or recession. If the interest rate increases and your monthly payment stays the same, your payments will not have as much of an impact as they did originally. To continue chipping away at your balance, you may want to make changes to your installment agreement.
Can I negotiate my payment amount?
The IRS generally calculates a minimum payment for you based on the information you enter when applying for an installment agreement. There isn’t much room for negotiation below that amount unless your income is low enough to warrant a PPIA. You are free, however, to pay more than the minimum payment.
How are payments applied?
The IRS applies payments to the tax first, then to penalties, and finally to accrued interest.
Can I pay my installment agreement early to avoid interest?
When your installment agreement application is approved, you are under no obligation to extend payments until the end of your installment agreement period. If you can pay in full before the end of your payment plan, doing so can save a significant amount of interest and penalties.
Does the IRS ever pay interest to taxpayers?
The IRS assesses interest on unpaid balances, but if the agency owes you money, it must pay you interest after a certain amount of time. Generally, if the IRS doesn't pay your refund within 45 days of the date you file, the agency will start adding interest to the refund.
Get Help With Your Tax Problems Now
If you’re facing tax difficulties and you’re not sure how to protect your financial future and well-being, you should discuss your concerns and goals with a tax professional. With the tax pro listings provided by TaxCure, you can learn about tax pros in your area and decide your next step. To get help now, use our site to search for a tax pro today.
Sources:
https://www.irs.gov/newsroom/options-for-taxpayers-who-need-help-paying-their-tax-bill
https://www.irs.gov/taxtopics/tc653
https://www.irs.gov/newsroom/interest-rates-remain-the-same-for-the-first-quarter-of-2024
https://www.irs.gov/pub/irs-pdf/n433.pdf
https://www.irs.gov/payments/payment-plans-installment-agreements
https://www.irs.gov/payments/quarterly-interest-rates#calculate
https://www.irs.gov/pub/irs-pdf/f13844.pdf