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IRS Lowers Its Interest Rates: What Does This Mean For You?

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Last updated 11/18/2024 by
SuperMoney Team
Edited by
Andrew Latham
Andrew Latham
Summary:
Understanding IRS interest rates is crucial for taxpayers with tax debt. These rates directly affect how much you owe and the cost of resolving your tax obligations. In 2025, rates for underpayments and overpayments will decrease, providing potential cost savings for taxpayers considering tax relief options.
The IRS adjusts interest rates quarterly, and the announcement of a decrease for the first quarter of 2025 is welcome news for taxpayers. Starting January 1, 2025, the interest rate for individual underpayments and overpayments will drop to 7%. For taxpayers with outstanding debts, this change may reduce the cost of repayment and present new opportunities for addressing tax obligations. If you owe back taxes or are considering tax relief, understanding these lower rates is critical for making informed decisions.

What are IRS interest rates?

IRS interest rates determine the costs or credits associated with unpaid or overpaid taxes:
  • Underpayment interest: This applies when taxes are not fully paid. The rate accrues daily, increasing the total amount owed over time.
  • Overpayment interest: The IRS compensates taxpayers for overpaid taxes through interest on the excess amount.
These rates are tied to the federal short-term rate, which is updated quarterly. For the first quarter of 2025:
  • Individuals face a 7% rate for both underpayments and overpayments.
  • Corporations experience varying rates, including 9% for large corporate underpayments and 4.5% for refunds on overpayments exceeding $10,000.

IRS interest rates over time

IRS interest rates have fluctuated over the years, reflecting changes in the federal short-term rate and broader economic trends. Below is a historical look at individual underpayment, overpayment, and large corporate underpayment rates since 2017:
Year/QuarterUnderpayment Rate (Individuals)Overpayment Rate (Individuals)Large Corporate Underpayment Rate
Q1 20257%7%9%
Q4 20248%8%10%
Q3 20248%8%10%
Q1 20237%7%9%
Q1 20223%3%5%
Q1 20213%3%5%
Q1 20205%5%7%
Q1 20196%6%8%
Q1 20184%4%6%
Q1 20174%4%6%
This historical perspective shows how rates tend to follow the broader economic cycle, increasing during periods of economic growth and tightening and decreasing during times of lower inflation or economic downturns.

How IRS interest is calculated

The IRS calculates interest using a daily compounding method, meaning that the interest accrues on the principal balance each day. Here’s how it works:
  • The interest rate is determined by adding 3 percentage points to the federal short-term rate for most individuals.
  • Interest is compounded daily, which means that each day’s interest is based on the total balance from the previous day, including any newly accrued interest.
  • Interest starts accruing from the due date of the tax return until the full balance is paid.
For example, if you owe $10,000 in unpaid taxes and the annual interest rate is 7%, the daily rate is approximately 0.0192%. Each day, the IRS calculates the interest on the unpaid amount plus the previous day’s accrued interest.
WEIGH THE RISKS AND BENEFITS
Here is a list of the benefits and the drawbacks to consider.
Pros
  • Lower interest rates reduce the overall cost of tax debt.
  • Improved affordability of installment agreements and other repayment options.
  • Potential savings for taxpayers managing large balances.
Cons
  • Interest still compounds daily, so balances grow over time.
  • Delaying payment could lead to higher costs despite rate reductions.
  • Programs like offers in compromise still require IRS approval.

Frequently asked questions

What is the new IRS interest rate for underpayments?

The rate for individual underpayments starting January 1, 2025, is 7% per year, compounded daily.

Does the rate decrease affect penalties?

No, the rate decrease applies only to interest on unpaid taxes or overpayments. Penalties are assessed separately.

What should I do if I owe back taxes?

Explore repayment options like installment agreements or offers in compromise. Lower interest rates make addressing tax debt more affordable, but acting quickly is key to minimizing costs.

Will the IRS pay me interest on overpayments?

Yes, if you overpay your taxes, the IRS compensates you with interest, currently at 7% for individuals starting in 2025. However, this interest is taxable income.

Key takeaways

  • The IRS will lower its interest rates for underpayments and overpayments to 7% for individuals in 2025.
  • Taxpayers with debt can benefit from reduced costs, but interest accrual continues daily.
  • Lower rates may make installment agreements and other relief programs more manageable.
  • Timely action is critical to minimize the financial impact of unpaid tax balances.

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