The IRS charges interest on unpaid taxes, even when you set up a payment plan

If you owe the IRS and arrange a payment plan to pay over time, interest still accrues on the balance you haven't paid yet. The IRS calls this the failure-to-pay penalty and interest—two separate charges that run until your debt is fully paid. Interest is calculated daily at a rate set by the IRS each quarter, currently around 8 percent annually (though this changes). The penalty is 0.5 percent of your unpaid tax per month, capped at 25 percent total. Both charges apply whether you pay in full immediately or spread payments across months or years.

The payment plan itself does not stop interest from running. It only lets you avoid a lump-sum demand and the threat of wage garnishment or bank levy while you pay. You are still responsible for the full amount owed plus all accrued interest and penalties by the time the final payment clears.

Key Takeaways

  • Interest on an IRS payment plan accrues daily at a rate the IRS sets each quarter, currently around 8 percent per year on the unpaid balance.
  • The failure-to-pay penalty adds 0.5 percent of your unpaid tax each month, up to a maximum of 25 percent of the original tax owed.
  • Both interest and penalties continue to accrue throughout the entire payment plan period, so the longer you take to pay, the more you owe in total.
  • Paying off the plan faster reduces the total interest and penalties you will owe, since both are calculated on the remaining balance.
  • The IRS offers a short-term extension (up to 180 days) with no setup fee, which may cost less than a formal payment plan if you can pay within that window.

How interest and penalties stack on a payment plan

When you enter a payment plan with the IRS, you are not pausing the clock on interest and penalties—you are just changing how you pay the total. The IRS continues to charge interest on whatever balance remains unpaid each day. If you owe $5,000 and set up a 12-month plan, interest accrues on $5,000 in month one, then on whatever is left after your first payment, and so on through month 12.

The failure-to-pay penalty works the same way. It accrues at 0.5 percent per month on the unpaid tax amount. If you owe $5,000 and make no payments for a full year, the penalty alone reaches $300 (0.5 percent × 12 months × $5,000). Add interest on top, and your total debt grows significantly beyond the original $5,000.

The longer your payment plan runs, the more interest and penalties you accumulate. A 60-month plan will cost more in total interest than a 24-month plan, even though your monthly payment is lower. This is why the IRS encourages faster repayment when possible.

The two types of IRS payment plans and their costs

The IRS offers a short-term extension and a formal installment agreement. The short-term extension lets you delay payment for up to 180 days with no setup fee. If you can pay the full amount within six months, this costs nothing extra—you still owe interest and penalties, but you avoid the installment agreement fee.

A formal installment agreement requires a setup fee (currently $31 to $225 depending on how you apply and your income level) and locks in a monthly payment amount. The IRS offers two types: a may provide installment agreement for balances under $50,000, and a streamlined installment agreement for balances under $25,000, which has a lower fee. Both charge interest and penalties throughout the plan period.

If your balance is under $50,000, you can set up a may provide agreement online through IRS.gov or by phone. If it is higher, you must work with the IRS directly, often through a payment arrangement specialist or a tax professional. Regardless of the type, interest and penalties continue to accrue on the unpaid balance.

What the IRS interest rate is and when it changes

The IRS sets its interest rate each quarter based on the federal short-term rate plus 3 percentage points. As of early 2024, the rate is approximately 8 percent per year, but it changes on January 1, April 1, July 1, and October 1 each year. You can find the current rate on IRS.gov or by calling the IRS.

Interest is compounded daily, meaning the IRS calculates interest on the interest you have already accrued. This compounds the total cost of a long payment plan. A $10,000 debt at 8 percent annual interest will cost roughly $800 in interest alone over one year if you make no payments. Over a five-year plan with regular payments, the total interest will be lower because the balance shrinks with each payment, but it will still be substantial.

If the interest rate rises during your payment plan, your interest charges will rise too. The IRS does not lock in a rate when you enter the plan. This is another reason to pay faster if you can: you avoid exposure to future rate increases.

How to reduce the total interest you pay

The most direct way to reduce interest is to shorten the payment plan. If you can pay in 24 months instead of 60, you cut the interest roughly in half. Even paying a few hundred dollars extra per month can save thousands in interest over the life of the plan.

If your financial situation improves during the plan, you can request to modify the agreement and increase your monthly payment. The IRS allows this without penalty. You can also make lump-sum payments toward the balance whenever you have extra money—the IRS applies these directly to principal, reducing the amount on which future interest is calculated.

Another option is to pay off the plan early in full. There is no prepayment penalty with the IRS. If you receive a tax refund, bonus, or inheritance, using it to clear the remaining balance stops all future interest and penalties immediately.

If your balance is small enough, the short-term extension (up to 180 days) costs nothing and may be worth using if you expect to have the money within six months. This avoids the installment agreement setup fee and limits the interest to what accrues over those six months rather than over a longer plan period.

What happens if you miss a payment on your plan

If you miss a payment, the IRS may terminate your agreement and demand the full remaining balance immediately. You will also face additional penalties: a failure-to-pay penalty continues to accrue, and the IRS may add a failure-to-file penalty if you did not file a return. Late payment penalties can reach 0.5 percent per month.

If you know you will miss a payment, contact the IRS before the due date. You can request a short-term delay or modify the plan to lower your monthly payment. The IRS is more flexible if you reach out proactively than if you simply skip a payment and wait for them to act.

If your agreement is terminated, you can request a new one, but the IRS may impose stricter terms or require a larger down payment. The unpaid balance will continue to accrue interest and penalties at the same rate as before.

Comparing a payment plan to other options

A payment plan is not your only option for handling an IRS debt. You can also request an offer in compromise, which lets you settle the debt for less than you owe if you can show financial hardship. This stops interest from accruing once the IRS accepts the offer, but the process takes months and the IRS rejects most offers.

You can also request currently not collectible status, which temporarily pauses collection action while interest and penalties continue to accrue. This is useful if you have no income or assets right now but expect your situation to improve. Once your finances recover, the IRS will resume collection.

A payment plan is usually the fastest and most straightforward option if you can afford a monthly payment. It keeps you in good standing with the IRS and stops them from taking collection action like wage garnishment or bank levy. The trade-off is that you pay interest and penalties for as long as the plan runs.

Frequently Asked Questions

Can I get the IRS to waive interest and penalties on a payment plan?

The IRS rarely waives interest, but it may reduce or remove penalties in specific cases—for example, if you had a reasonable cause for not paying on time, such as a serious illness or a death in the family. You must request this in writing and provide documentation. Interest itself is almost never waived; it is a legal charge on unpaid federal tax debt.

Does the interest rate on my payment plan change if the IRS rate goes up?

Yes. The IRS does not lock in an interest rate when you enter a payment plan. If the federal rate rises and the IRS adjusts its rate on January 1, April 1, July 1, or October 1, your interest charges will increase on the remaining balance. This is another reason to pay off the plan as quickly as possible.

What if I can pay off the plan early—do I owe a penalty?

No. The IRS allows you to pay off an installment agreement at any time without prepayment penalty or fee. Paying early stops interest from accruing on the remaining balance, so it saves you money. You can make extra payments whenever you have the funds.

Is the setup fee for a payment plan tax-deductible?

The IRS setup fee is not tax-deductible. However, if you hire a tax professional or attorney to help you set up or negotiate the plan, their fees may be deductible as a miscellaneous expense if you itemize deductions. Consult a tax professional about your specific situation.

How much will my payment plan cost in total if I owe $8,000?

That depends on how long the plan runs and the current interest rate. At 8 percent annual interest, a 24-month plan on $8,000 will cost roughly $800 to $1,000 in interest plus the setup fee (currently $31 to $225). A 60-month plan will cost significantly more. Use the IRS payment plan calculator on IRS.gov to estimate your specific total.