The IRS charges interest and penalties on top of what you owe, whether you pay in full or set up a payment plan
The interest rate the IRS charges is set by law and changes every quarter. As of early 2024, the rate is 8 percent per year, compounded daily. That rate applies to both the original tax debt and any penalties. The IRS does not reduce interest or penalties because you chose a payment plan instead of paying in full — you pay the same total interest either way, just spread across months or years.
Penalties are separate from interest. The most common is the failure-to-pay penalty, which is 0.5 percent of what you owe per month (or part of a month) that you do not pay. If you also filed your return late, you may owe a failure-to-file penalty on top of that. Both penalties stop accruing once you pay in full, but they keep growing while you are on a payment plan.
The IRS also charges a setup fee to create a payment plan. That fee depends on how you set up the plan and ranges from $31 to $225. Direct debit (automatic withdrawal from your bank account) costs less than paying by check or card.
Key Takeaways
- The IRS interest rate is 8 percent per year as of early 2024 and changes quarterly, compounded daily on your full balance including penalties.
- The failure-to-pay penalty is 0.5 percent per month you do not pay, and it keeps growing while you are on a payment plan.
- A payment plan setup fee ranges from $31 to $225 depending on whether you use direct debit or another payment method.
- You pay the same total interest whether you pay in full or use a payment plan — the plan only spreads the cost over time.
- Interest and penalties stop accruing only after you pay your entire balance, so longer payment plans cost more in total interest.
How the IRS interest rate is set and when it changes
The IRS interest rate is tied to the federal short-term rate plus 3 percentage points. Congress sets this formula in the tax code, and the IRS publishes a new rate every three months. The rate changes on January 1, April 1, July 1, and October 1 each year. If you are already on a payment plan when the rate changes, your new payments will reflect the new rate going forward.
You can find the current IRS interest rate on the IRS website under "Interest Rates." The rate has ranged from 3 percent to 8 percent over the past decade, depending on broader economic conditions. If you are setting up a payment plan now, ask the IRS or your tax professional what the current rate is, because it may have changed since you received your notice.
Failure-to-pay penalty and how it works on a payment plan
The failure-to-pay penalty is 0.5 percent of your unpaid tax per month or part of a month. If you owe $5,000 and do not pay for three months, the penalty grows by $75 (0.5 percent × $5,000 × 3 months). That penalty is added to your balance, and interest is then charged on the penalty as well.
On a payment plan, this penalty keeps accruing every month until you pay your full balance. A 24-month plan means the penalty will grow for 24 months. The penalty can reach a maximum of 25 percent of your original tax debt, at which point it stops growing. For most people, the penalty hits that cap before the debt is paid off.
You can reduce or remove the failure-to-pay penalty if you show reasonable cause — for example, a serious illness or a death in your family that prevented you from paying. The IRS calls this a penalty abatement request. You must request it in writing and explain why you could not pay. There is no may provide the IRS will grant it, but it is worth asking if your situation was genuinely beyond your control.
Setup fees for different payment plan methods
The IRS charges a one-time fee to set up a payment plan. The fee depends on how you set it up:
| Payment Method | Setup Fee |
|---|---|
| Direct debit (automatic bank withdrawal) | $31 |
| Credit or debit card | $225 |
| Check or money order | $225 |
| Electronic Federal Tax Payment System (EFTPS) | $31 |
Direct debit and EFTPS are the cheapest options because they reduce the IRS's processing costs. If you can set up automatic withdrawals from your bank account, you will save $194 compared to paying by card or check. The setup fee is added to your payment plan balance, so you will pay interest on it as well.
How interest compounds while you are on a payment plan
Interest compounds daily, meaning the IRS calculates interest on your balance, then adds that interest to your balance, and then calculates interest on the new, larger balance the next day. Over a long payment plan, this compounds significantly.
Here is a simplified example: if you owe $10,000 in tax and penalties, and the interest rate is 8 percent per year, the IRS charges about $22 in interest on the first day. That $22 is added to your balance, making it $10,022. The next day, interest is calculated on $10,022, not $10,000. Over a 24-month payment plan with no additional penalties accruing, you would pay roughly $1,000 to $1,200 in interest alone, depending on how much you pay each month.
The longer your payment plan, the more interest you pay in total. A 12-month plan costs less in interest than a 24-month plan, even though your monthly payment is higher. If you can afford a shorter plan, you will save money.
What happens if you miss a payment on your plan
If you miss a payment, the IRS may terminate your payment plan and demand the full balance immediately. Before that happens, the IRS will send you a notice giving you a chance to catch up. You typically have 30 days to make the missed payment or contact the IRS to explain.
If your plan is terminated, you will owe the entire remaining balance at once. You can request a new payment plan, but you will pay another setup fee. Missing payments also does not stop interest or penalties from accruing — they keep growing while you are in default.
If you know you cannot make a payment, contact the IRS before the due date. You may be able to adjust your payment amount, extend your plan, or temporarily pause payments if you are facing a hardship. The IRS has a hardship process, though it requires documentation.
How to reduce what you owe before setting up a payment plan
Interest and penalties are calculated on your tax debt, so reducing the debt itself is the most direct way to reduce what you will pay in interest. If you believe the IRS made an error in calculating your tax, you can file a dispute called a Notice of Disagreement. This does not stop interest from accruing, but if you win, the interest calculation will be adjusted retroactively.
You can also request an Offer in Compromise, which is a settlement where you pay less than the full amount owed. The IRS will only accept an Offer in Compromise if you can show you cannot pay the full debt, even over time. The process takes several months and requires detailed financial information. If accepted, you pay a lump sum and the debt is closed.
Another option is Currently Not Collectible status, which temporarily pauses collection efforts and stops some penalties from accruing. Interest still accrues, but you do not have to make payments while you are in financial hardship. This status lasts up to two years and can be renewed if your situation does not improve.
Frequently Asked Questions
Does the IRS charge interest on the setup fee?
Yes. The setup fee is added to your payment plan balance, and interest is calculated on it just like the rest of your debt. This is why using direct debit saves money — the lower fee means less interest accrues on the fee itself.
Can I pay off my payment plan early without a penalty?
Yes. The IRS does not charge a penalty for paying off a payment plan early. If you pay the full balance before your plan ends, interest stops accruing on the remaining balance. You will save money on interest by paying early if you can.
What if the IRS interest rate goes up while I am on a payment plan?
Your payment plan does not lock in the interest rate. When the IRS rate changes quarterly, the new rate applies to your remaining balance going forward. Your monthly payment amount does not automatically change, but more of each payment will go toward interest and less toward principal.
Is there a way to stop penalties from accruing on a payment plan?
Penalties stop accruing only when you pay your full balance. You can request a penalty abatement to reduce or remove penalties if you have reasonable cause, but this requires a written request and explanation. The IRS does not grant abatement automatically.
How do I know what my total interest will be by the end of my payment plan?
The IRS cannot give you an exact number because interest compounds daily and the rate changes quarterly. When you set up your plan, the IRS will show you an estimate based on current rates and your monthly payment. Ask for this estimate in writing so you have it for your records.