Section 6621: Determination of Rate of Interest

The Internal Revenue Service (IRS) uses Section 6621 of the Internal Revenue Code to determine the interest rates applied to both tax underpayments and overpayments. This section ensures that the IRS receives interest on any unpaid taxes and taxpayers are compensated for any tax payments made in excess.

A. Interest Rates:

Overpayment Rate

This is the interest rate you earn on any tax amount you pay in excess of your actual tax liability. The rate is calculated by adding 3 percentage points (or 2 percentage points for corporations) to the federal short-term rate. However, there's an exception for corporations: any portion of an overpayment exceeding $10,000 for a taxable period earns a lower interest rate, calculated by adding just 0.5 percentage points to the federal short-term rate.

Underpayment Rate

This is the interest rate you are charged on any tax amount you owe the IRS. The underpayment rate is generally higher than the overpayment rate and is determined by adding 3 percentage points to the federal short-term rate. There's one key difference for large corporations (defined later).

B. Federal Short-Term Rate

This is a critical factor in calculating both overpayment and underpayment rates. It's the interest rate set by the Secretary of the Treasury each month, based on the rate earned on certain short-term U.S. Treasury securities. The federal short-term rate fluctuates throughout the year.

C. Large Corporate Underpayment

Section 6621(c) introduces a higher interest rate for large corporations that significantly underpay their taxes. For these underpayments, the 3 percentage point addition to the federal short-term rate is increased to 5 percentage points.

How do I find the current interest rates?

The IRS publishes the federal short-term rates monthly on their website https://www.irs.gov/payments/quarterly-interest-rates.

Can I negotiate the interest rate on my tax underpayment?

Generally, no. The IRS sets the interest rates by law, and they are not negotiable. However, you may be eligible for penalty relief if you can demonstrate reasonable cause for your late payment.

How is the interest compounded?

The IRS compounds interest daily on both tax underpayments and overpayments. This means interest is earned on the initial amount owed or overpaid, as well as on the accumulated interest.

Is there a penalty for late tax payments in addition to interest?

Yes, in addition to interest, the IRS may also assess late payment penalties on any unpaid taxes.

How can I avoid interest charges on taxes owed?

The best way to avoid interest charges is to pay your taxes in full and on time. You can also consider making estimated tax payments throughout the year to minimize any potential underpayment.