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When you owe the IRS money, the IRS charges you interest.  In addition, with certain exceptions, when the IRS owes the taxpayer money, the IRS will pay the taxpayer on that amount.

 

You are subject to what is called "assessed interest" when you owe the IRS money. The IRS assesses the interest and adds it on to the tax bill itself.  IRS interest rates charged on underpayment can change; these are variable rates, not fixed rates.  IRS interest rates are tied to the Federal Reserve interest rates.  Other factors can change the interest rate charged, such as what amount the taxpayer owes and whether the taxpayer is a corporation.  The current interest rate for assessed interest for individual taxpayers is 4 percent of the underpaid taxIt's important to recognize that this interest is compounded daily, not "simple interest," meaning that IRS charges "interest on interest," not just interest on the principal. 

 

When there is an overpayment of tax, the IRS pays the taxpayers interest, which is called "statutory interest".  This type of interest may be paid if the IRS pays a late refund.  Like "assessed interest", this rate is currently also at 4 percent, also variable and also tied to the Federal Reserve interest rate.  An overpayment of tax occurs when a taxpayer pays more tax for a particular year than they actually owe for that year.  In essence, they have given the IRS a loan.  Interest cannot start to accrue until after April 15th.  The IRS evaluates whether they are going to pay statutory interest on a case by case basis.   

   

When taking out a loan that includes interest there are two main concerns that you should pay attention to:

 

1) The amount on which the interest will be charged/paid.

 

2) The date on which the interest starts accruing.

 

The IRS also considers these two factors when calculating their interest rates.

 

The concept of base amounts pertains to the amount of tax upon which interest is being charged or paid.  In a simple situation, if you owed $1,000 in tax, then $1,000 would be the base amount and the interest rate would be applied to it.

  

The second concept of time considerations goes to the idea of when exactly the interest will start to be charged or paid.  In simple situations, the interest is charged starting with the due date of your tax payment, which is April 15.