Every once in a while, we receive some good news from the IRS. Here’s the latest.
Every once in a while, we receive some good news from the IRS. Today is one of those days! The IRS recently announced changes to the interest rates used to calculate underpayments and overpayments on income tax payments sent to the agency. The bottom line is that underpayments will accrue interest charges at significantly lower rates than before. The new changes go into effect on Oct. 1, 2011.
When the IRS doesn’t receive payments due on time, there are two types of charges incurred: penalties and interest. There is a long list of penalties depending on the nature and reason for not paying the full amount of taxes due—that’s a topic for another article. In addition to the penalty, you will also have to pay interest from the date the tax payment was due usually until the day in which the IRS receives the amount of underpayment. Late payments can happen for several reasons. In some cases a company simply fails to send the full amount due to an error or a lack of funds. In other cases, estimated taxes are sent to the IRS late or are grossly inadequate.
How much interest do I have to pay?
Section 6621 defines the interest rate to be charged on underpayments. The IRS sets this interest rate on a quarterly basis. It consists of the sum of two numbers: The Federal short-term interest rate and a fixed percentage amount.
Federal short-term interest rate
The Federal short-term interest rate is published monthly and is available on the IRS website. The rate for daily compounding is the appropriate one to use because the IRS ruled as such in Notice 88-59. Rather than just taking that interest rate, the IRS requires that the rate be rounded. Because rates are so low, they are currently rounded to zero. This has left the false impression that only the fixed percentage amount is interest rate. When rates go up, so will the short-term interest rate.
Fixed percentage amount
Starting with the fourth quarter of 2011, the IRS has announced that they will reduce the fixed percentage component of the interest rate. For non-corporate tax payers, it is generally defined as the sum of the Federal short-term interest rate plus 3 percentage points. For corporate tax payers with small underpayment amounts, the interest rate calculation is the same. For corporate tax payers with large underpayment amounts, the interest rate is the calculated as the sum of the Federal short-term interest rate plus 5 percentage points.
