Tax payment plans are not interest-free, but the interest rate is set by law

The IRS charges interest on any federal income tax you owe, whether you pay in full immediately or set up a payment plan. The interest rate changes quarterly and is based on the federal short-term rate plus 3 percent. As of early 2024, the rate sits around 8 percent per year, but this varies. You will also owe a failure-to-pay penalty of 0.5 percent per month on the unpaid balance, unless you have a reason the IRS accepts for the delay.

The payment plan itself—called an installment agreement—does not add extra charges on top of the interest and penalties you already owe. What it does is let you spread those costs across months or years instead of paying everything at once. The interest and penalty keep accruing on the unpaid balance until you finish paying.

State tax agencies work the same way. Most states charge interest on unpaid tax debt, and many add penalties as well. The rates vary by state, so you need to check with your state tax authority for the exact numbers.

Key Takeaways

  • The IRS charges interest on unpaid federal tax at a rate set by law, currently around 8 percent annually, which changes every quarter.
  • You will also owe a failure-to-pay penalty of 0.5 percent per month on the unpaid balance unless you have an accepted reason for the delay.
  • A payment plan lets you spread payments over time but does not stop interest and penalties from accruing on what you still owe.
  • State tax agencies charge their own interest and penalties, which vary by state and should be confirmed before you set up a plan.
  • The IRS offers payment plans with no setup fee if your balance is under $25,000, but fees apply for larger amounts or if you miss a payment.

How interest accrues while you are on a payment plan

Interest compounds daily on your unpaid tax balance. If you owe $5,000 and the interest rate is 8 percent, you accrue roughly $1.10 per day in interest alone. That amount gets added to your balance, and the next day's interest is calculated on the new, higher total. Over a year, that compounds to around $412 in interest on the original $5,000.

The failure-to-pay penalty works differently. It is a flat 0.5 percent per month (0.005 times your unpaid balance) and does not compound. On $5,000, that is $25 per month. The penalty stops accruing once you pay the full balance, but interest keeps running until the last payment clears.

Both interest and penalty are added to your account automatically. You do not have to do anything to incur them—they are part of owing the tax. The payment plan does not reduce or pause either one.

Setup fees and other costs tied to installment agreements

The IRS charges a setup fee to create an installment agreement, but the amount depends on how you apply and how much you owe. If you set up a plan online through IRS.gov, the fee is $31 if your balance is under $25,000. If you call or mail in your request, the fee is $225 for the same balance. For balances over $25,000, the fee is $225 regardless of method.

If you miss a payment or fail to pay on time, the IRS may charge a $25 failure-to-pay-installment-agreement penalty. This is separate from the ongoing failure-to-pay penalty on your tax debt itself.

Some states also charge fees for payment plans, but the amounts vary. Check your state tax authority's website or call them directly to learn what you will owe.

Types of payment plans and which one costs less

The IRS offers two main types of installment agreements: short-term and long-term. A short-term agreement lets you pay off your balance within 120 days with no setup fee. This is the cheapest option because you avoid the $31 or $225 fee entirely, and interest accrues for only a few months instead of years.

A long-term agreement spreads payments over more than 120 days, up to six years or longer depending on your balance. You pay the setup fee ($31 online, $225 by phone or mail), and interest accrues for the entire length of the plan. The longer the plan, the more total interest you pay, even though your monthly payment is smaller.

For example, if you owe $3,000 and pay it off in three months, you might pay $60 in interest. If you stretch the same debt over three years, you could pay $700 or more in interest, plus the setup fee. The math changes based on the interest rate at the time, but the principle is the same: shorter plans cost less in total interest.

What happens if you cannot pay the full amount even with a plan

If your balance is very large or your income is very low, you may not be able to afford even a long-term payment plan. The IRS has a process called Currently Not Collectible status that pauses collection efforts temporarily. Interest and penalties still accrue, but you do not have to make monthly payments while your financial situation improves.

Currently Not Collectible status is not permanent. The IRS reviews your case every two years, and if your income increases, they will restart collection. Interest and penalties keep running the entire time, so your total debt grows even though you are not paying.

You can also request an Offer in Compromise, which lets you settle your tax debt for less than you owe. This requires proving that paying the full amount would create genuine financial hardship. The IRS approves only a small percentage of these requests, and the process takes months.

State tax payment plans and their interest rates

Most states allow payment plans for unpaid state income tax, but the interest rates and penalties vary widely. Some states charge interest at a fixed rate set in law; others tie it to a federal rate plus a state markup. A few states charge no interest on payment plans under certain conditions, though this is rare.

For example, California charges interest at 0.5 percent per month (6 percent annually) on unpaid tax, plus penalties that can reach 25 percent of the unpaid amount depending on the reason for the delay. New York charges interest at the federal rate plus 2 percent, plus penalties ranging from 5 to 75 percent. Texas has no state income tax, so there is nothing to plan.

Contact your state tax authority directly or visit their website to learn the exact interest rate and penalties that apply to your situation. The rate may depend on whether you filed late, paid late, or underpaid during the year.

How to reduce the total cost of a payment plan

The fastest way to cut costs is to pay off the debt as quickly as you can manage. Even paying an extra $50 or $100 per month reduces the number of months interest accrues and saves money in the long run. Use an online calculator or ask the IRS to show you how much interest you will pay under different payment schedules.

If you receive a tax refund in a future year while you are on a payment plan, the IRS will automatically apply that refund to your unpaid balance. This reduces the amount still owed and stops interest from accruing on that portion. You cannot stop this from happening, but it does help you pay down the debt faster.

Setting up your plan online through IRS.gov saves you $194 in setup fees compared to calling or mailing in a request. If your balance is under $25,000 and you can pay it off within 120 days, a short-term agreement avoids the setup fee entirely.

Frequently Asked Questions

Can I get the IRS to waive the interest on my payment plan?

The IRS does not waive interest on payment plans. Interest is required by law and accrues automatically on any unpaid federal tax. You can request that the IRS waive or reduce penalties in some cases—for example, if you have a clean payment history and a reasonable cause for the delay—but interest cannot be removed.

Does a payment plan stop penalties from accruing?

No. The failure-to-pay penalty of 0.5 percent per month continues to accrue on your unpaid balance while you are on a payment plan. It stops only when you pay the full amount owed. Some penalties can be reduced or removed if you request relief and have a valid reason, but the ongoing failure-to-pay penalty is automatic.

What is the difference between a payment plan and a settlement offer?

A payment plan lets you pay the full amount you owe over time, with interest and penalties still accruing. A settlement offer (Offer in Compromise) lets you pay less than the full amount if you can prove financial hardship. Settlement offers are harder to get, take longer to process, and are approved only in limited cases.

If I set up a state payment plan, do I still owe federal interest too?

Yes. State and federal tax are separate debts. If you owe both, you need to handle each one separately. A state payment plan covers only your state tax debt and does not affect your federal tax debt or the interest accruing on it. Contact both the IRS and your state tax authority to set up plans for each.

Will making extra payments reduce my interest?

Yes. Every dollar you pay reduces your unpaid balance, and interest is calculated on that balance. Paying extra stops interest from accruing on that portion of the debt. If you can afford to pay more than your monthly plan amount, doing so will reduce your total interest cost.