How and Why To Calculate IRS Interest and Penalties

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IRS Interest Calculations

     Why Compute IRS Interest

If you owe the IRS, the IRS will charge interest on the unpaid tax.  Since IRS interest is compounded daily, this can be a large number, if you owe tax past the due date.  This can grow to be a large number.  If you are planning to settle up with the IRS, it is helpful to know how much interest you might owe.  The two most common situations where you might owe the IRS would be filing an amended tax return or settling a dispute with the IRS.

For an amended tax return where you might owe taxes, the IRS will bill you after you file the amended tax return.  Unless you have unlimited resources, it use useful to know in advance how much interest you might be billed for.  Also, if you pay interest with the amended tax return, you can reduce the total interest owed. That is because you won't be charged interest for the time that the IRS takes to process the amended tax return.

If you are a settling a prior year dispute with the IRS, interest can be a large amount.  Computing the interest in advance can reduce the chance of an unpleasant additional surprise when the IRS produces the final bill for taxes owed.

     How to Compute IRS Interest

This is not something that you want to do yourself! You will need to get a copy of the most current Revenue Ruling that lists the IRS interest rates over time.  These rates can change for every calendar quarter from a low of 3% to a high of 20% (1982).  If there are penalties or tax payments, the amount that interest is computed on can change with each penalty or tax payment.

Rather than using a formula to compute the interest, IRS Revenue Procedure 95-17 includes interest rate factors based on a specific interest rate and days.  It is important to use the right interest rate table depending on whether part of your computation is in a leap year or a non-leap year.

If you don't want to go through this hassle, you can use an IRS Interest and Penalty Calculator.  I use the DTS Interest and Penalty Calculator. This software can professionally document the computations, and it is used by many other tax professionals including Fortune 100 companies and CPA firms.