The IRS charges interest on unpaid taxes, and that interest keeps running while you pay through an installment agreement

The federal short-term rate sets the base interest rate, which the IRS updates quarterly. As of early 2024, that rate is 8 percent per year, though it changes. The IRS also adds a penalty on top of interest — usually 0.5 percent per month of the unpaid tax, though it can be higher if you don't file or pay on time. Both the interest and penalty accrue daily, meaning they grow every single day your balance sits unpaid, even while you're making monthly installment payments.

The total you owe grows faster than your monthly payment covers, especially in the first months of the plan. If you owe $10,000 and set up a 60-month plan, you're not paying $167 per month — you're paying $167 plus interest and penalties that month, then a slightly higher interest charge the next month because the balance hasn't dropped as fast as the interest has grown. The IRS publishes the exact rate each quarter on its website, but you won't see a single interest rate quoted in your payment plan agreement; instead, you'll see the monthly payment amount, which already accounts for interest.

Key Takeaways

  • Interest accrues daily on unpaid taxes at the federal short-term rate (currently 8 percent annually, updated quarterly) plus a penalty of 0.5 percent per month, and both continue while you make installment payments.
  • Your monthly payment covers both principal and interest, but interest is calculated first, so early payments go mostly toward interest rather than reducing what you owe.
  • Shorter payment plans cost less in total interest — a 24-month plan costs significantly less than a 72-month plan on the same debt.
  • The IRS publishes the current interest rate quarterly on its website, and you can request a payment plan estimate that shows the total interest you'll pay over the life of the plan.
  • Interest stops accruing only when your balance reaches zero, so paying extra toward principal reduces the total interest you'll owe.

How the IRS calculates interest on your monthly payment

Each month, the IRS calculates interest on your remaining balance first, then applies your payment. If you owe $10,000 at 8 percent annual interest, that's roughly $67 in interest for the first month alone. Your $200 monthly payment covers that $67 in interest, leaving only $133 to reduce the principal. The next month, your balance is $9,867, so the interest charge is slightly lower — but the pattern repeats. Early in a payment plan, most of your payment goes to interest, not to paying down what you actually owe.

This is why the length of your payment plan matters so much. A 24-month plan on $10,000 costs far less in total interest than a 72-month plan on the same amount. The IRS offers several plan lengths: short-term plans (120 days or less), standard installment agreements (up to 72 months depending on the amount owed), and long-term agreements for larger debts. You can request a payment plan estimate from the IRS before you commit, and that estimate will show you the total interest and penalties you'll pay over the full term.

The penalty that stacks on top of interest

Beyond interest, the IRS charges a failure-to-pay penalty of 0.5 percent per month on any unpaid tax. This penalty accrues separately from interest and also compounds daily. If you set up a payment plan, the penalty continues to accrue until your balance is paid in full — it doesn't pause or reduce because you're making payments. The penalty can reach a maximum of 25 percent of the unpaid tax, at which point it stops growing, but that can take years.

Some taxpayers also face a failure-to-file penalty if they didn't file a return on time, which is 5 percent per month (up to 25 percent). If both penalties apply, they can compound quickly. The IRS may reduce or remove penalties in limited cases — for example, if you have a history of filing on time and paying, or if you can show reasonable cause for the delay — but you have to request that relief, and it's not automatic.

What happens if you pay off the plan early

Paying off your installment agreement early stops interest and penalties from accruing on the remaining balance. If you have $5,000 left on a plan and you pay it in full, the interest stops immediately. There's no prepayment penalty with the IRS — you can pay as much as you want whenever you want without extra fees. This makes paying extra toward principal one of the few ways to reduce your total cost.

Some taxpayers receive a tax refund while on a payment plan. The IRS will automatically apply that refund to your remaining balance, which reduces what you owe and stops interest from accruing on that amount. You can't prevent this offset, but it works in your favor because it cuts both the principal and the future interest.

How to find the current IRS interest rate

The IRS publishes its interest rate quarterly — on January 1, April 1, July 1, and October 1 each year. You can find the current rate on the IRS website under "Interest Rates" or by calling the IRS at 1-800-829-1040. The rate is based on the federal short-term rate plus 3 percentage points. When the federal rate changes, your IRS interest rate changes with it, usually within a few weeks.

If you're already on a payment plan, your interest rate doesn't change mid-agreement — the rate you agreed to stays the same for the life of the plan. But if you set up a new plan or modify an existing one, the new rate applies. The IRS will tell you the exact rate and the total interest you'll pay when you request a payment plan estimate.

Comparing payment plan lengths and total cost

The IRS offers different plan lengths depending on how much you owe. For amounts under $25,000, you can typically choose a plan up to 72 months. For larger amounts, longer terms are available. Here's the trade-off: a shorter plan means higher monthly payments but much lower total interest. A longer plan spreads the cost over more months but costs significantly more in total interest because interest accrues for longer.

For example, owing $5,000 at 8 percent interest with a 0.5 percent monthly penalty looks very different over 24 months versus 60 months. The 24-month plan has a higher monthly payment but saves you hundreds in total interest. The 60-month plan has a lower monthly payment but costs more overall. The IRS payment plan estimator (available on IRS.gov or through a tax professional) shows you both the monthly payment and the total interest for each option, so you can decide what fits your budget.

What to do if you can't afford the monthly payment

If your payment plan payment becomes unaffordable, you can request a modification. The IRS allows you to extend the plan, lower the monthly payment, or switch to a different plan type. However, extending the plan means interest accrues for longer, so your total cost increases. The IRS also offers an offer in compromise, which is a settlement for less than you owe, but that's a separate process with its own rules and is rarely approved.

If you fall behind on your payment plan, the IRS can terminate the agreement and pursue collection action, including wage garnishment or bank levy. Interest and penalties continue to accrue even after the plan is cancelled. If you're struggling, contact the IRS as soon as possible — they have hardship programs and can work with you before the situation escalates.

Frequently Asked Questions

Does the IRS charge interest on payment plans for state taxes too?

No, this article covers only federal IRS taxes. State tax agencies set their own interest rates and penalties, which vary by state. Contact your state tax authority or a tax professional for information about state payment plans.

Can I deduct the interest I pay on a tax payment plan?

Interest on federal income taxes is not deductible for individuals. Businesses may be able to deduct interest on certain business taxes, but you should consult a tax professional about your specific situation.

What if I disagree with the interest amount the IRS calculated?

You can request an explanation from the IRS, and they will provide a detailed breakdown. If you believe there's an error, you can file a dispute through the IRS appeals process, but you'll need documentation to support your claim. A tax professional or the Taxpayer Advocate Service can help.

Does interest stop accruing if I'm on a payment plan?

No. Interest and penalties continue to accrue daily until your balance reaches zero, even while you're making regular monthly payments. This is why paying extra toward principal reduces your total cost.

What's the difference between interest and the failure-to-pay penalty?

Interest is the cost of borrowing money from the IRS (currently 8 percent annually). The failure-to-pay penalty is a separate charge of 0.5 percent per month for not paying on time. Both accrue daily and both continue while you're on a payment plan.