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Lane Keeter, CPA

Partner: Tax Consulting, Estate Planning, and Heber Springs Managing Partner

IRS Interest Rates Increase

Interest rates charged by the IRS for tax underpayments (and paid by them for overpayments) is largely a function of how overall interest rates are moving. More specifically, most are tied to the "federal short-term rate", so as this rate moves, the IRS rate moves also.

As such, the IRS interest rates have been relatively low, from an historical perspective, for quite some time. Going back to around the time of the 2008 financial system crisis, for the most of that period the rate charged for underpayments has hovered in the 3 to 4% range. 

But with inflation ramped up and the Federal Reserve raising interest rates, this is changing, with all indications being that rates will be a bit volatile, rising frequently in the future. By law, IRS rates are evaluated and changed as needed quarterly.

Accordingly, the IRS recently announced that interest rates will increase July 1, 2022, and will be as follows:

  • 5% for overpayments (4% in the case of a corporation).
  • 2.5% for the portion of a corporate overpayment exceeding $10,000.
  • 5% for underpayments.
  • 7% for large corporate underpayments. 

Now, if you are someone who is never "late" filing/paying your income taxes' you may be thinking, why is this important to me?

For one thing, many taxpayers are unwittingly "late" paying some of their tax without realizing it, and even if their tax returns are timely filed and any taxed owed paid at that time. This is because the tax code requires you to pay in a certain amount of your final tax bill as you go during the year either through tax withholding or by making estimated tax payments on designated dates. 

For most, the minimum required to be paid in during the year is the lesser of:

(1) 100% of your total prior year tax liability (so for 2022, 100% of the 2021 total tax per your return), or 

(2) 90% of your total current year tax liability. 

I call these the "safe harbor" amounts, meaning as long as you meet one of these tests as of each applicable date, you are safe from any consequence. The due dates for doing this are April 15, June 15, September 15 and January 15 of the following year. Tax withholding, by the way, is considered to have been paid in evenly throughout the year, regardless of when actually withheld. 

Failure to pay in at least one of the above safe harbor amounts on or before the required due date can result in what the IRS calls the Underpayment of Estimated Tax Penalty. In reality, it's not so much a penalty as it is an interest charge. That's because it is calculated just like interest on a loan would be. 

In other words, if on June 15 you should have paid in $1,000 but only have paid $400, the underpayment interest rate referred to above with be used to accrue the so-called penalty from June 15 until whatever later date it is ultimately paid. 

Side note, I've always found it somewhat interesting that the tax code refers to the above as a penalty, when it really is nothing more than interest. Obviously, "penalty" can and does induce all kinds of negative emotional responses, whereas interest, well, not so much. Believe it or not, the tax law is full of all kinds of psychological ploys like that.

Anyway, a second reason to care is if you are due a tax refund. If so, you likely have experienced a significant delay in receiving the refund due to the Covid-19 induced work stoppage at the IRS and resulting logjam and delays in processing returns. The IRS is obligated in most cases to pay interest to you for refund delays that exceed a certain amount of time. 

States also have similar rules to these. For instance, the State of Arkansas has virtually the same rules as shown above with a major exception. Arkansas's interest rate is a flat (and unchanging) 10% across the board. Pretty stiff! This is why in situations where a client owes both the IRS and the State, but can't pay it all off right away, I often counsel paying Arkansas first to get rid of that charge, and settle with the IRS later when they can. 

Overall, that saves them some money. Well, at least for now that is. If IRS rates continue to climb, that could change. I remember full well at time long ago when IRS rates were higher than 10%. Let's pray we don't get there again!

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