Yes, the IRS charges interest on payment plans, and the rate changes quarterly
When you set up a payment plan with the IRS to pay taxes over time instead of in full, you owe interest on the unpaid balance. The IRS calls this the underpayment rate, and it is not a flat fee — it compounds daily and changes every three months based on the federal short-term rate.
The current underpayment rate is 8% per year as of the fourth quarter of 2024, though this shifts in January, April, July, and October each year. The IRS publishes the new rate on its website before each quarter begins. You pay interest from the original due date of the tax return, not from the date you set up the plan.
You also owe a failure-to-pay penalty of 0.5% per month on any unpaid balance, separate from the interest. This penalty stops accruing once you have paid in full. Both the interest and the penalty are added to your balance each month, so the longer the plan runs, the more you owe beyond the original tax.
Key Takeaways
- The IRS charges interest at a rate that changes quarterly; you can find the current rate on IRS.gov before each quarter begins.
- Interest compounds daily on your unpaid balance from the original tax due date, not from when you start the payment plan.
- A separate failure-to-pay penalty of 0.5% per month also accrues on unpaid taxes, in addition to interest.
- Shorter payment plans cost less in total interest and penalties because the balance sits unpaid for less time.
- You can pay off the plan early without penalty, which stops both interest and penalty from continuing to accrue.
How the interest rate is set and when it changes
The IRS bases its underpayment rate on the federal short-term rate published by the Treasury Department, then adds 3 percentage points. This combined rate applies to all taxpayers and does not vary by credit score, income, or the reason for the payment plan.
The rate is locked in for each three-month quarter. If you start a payment plan in February, you pay the Q1 rate (January–March) until April 1, when the Q2 rate takes effect. The IRS announces the new rate before each quarter, so you can see what you will owe going forward. A rate increase does not retroactively change what you already paid; it only applies to interest accruing after the change date.
If the federal rate drops, your interest rate drops too. During 2020 and 2021, the underpayment rate fell to 3% because the federal short-term rate was near zero. In 2023 and 2024, rates climbed as the Federal Reserve raised short-term rates to combat inflation.
What you actually pay each month on a payment plan
Your monthly payment covers three things: a portion of the original tax, the interest that accrued that month, and the failure-to-pay penalty. The IRS calculates the payment amount to spread the original tax evenly over the plan term, but interest and penalties are added on top.
For example, if you owe $5,000 in tax and set up a 24-month plan, your base monthly payment might be around $208. But interest at 8% annually compounds daily on the remaining balance, so your first month's interest is roughly $33. The 0.5% monthly failure-to-pay penalty adds another $25. Your actual first payment is closer to $266, and the amount changes slightly each month as the balance shrinks and interest recalculates.
The IRS does not itemize interest and penalties separately on your bill; you see one payment amount. But you can request an Individual Taxpayer Identification Number (ITIN) transcript or a payment history from the IRS to see how much of each payment went to tax, interest, and penalties.
Installment agreement types and how interest differs
The IRS offers three main types of payment plans, and interest accrues on all of them, but setup costs and monthly fees vary.
| Plan Type | Setup Cost | Monthly Fee | When Interest Starts |
|---|---|---|---|
| Short-term (120 days or less) | None | None | Original due date |
| Standard (over 120 days, set up online) | $31 to $225 | None | Original due date |
| Standard (over 120 days, by phone or mail) | $31 to $225 | None | Original due date |
The setup fee is a one-time cost, not interest. It is deducted from your first payment or added to your balance. Interest, by contrast, accrues every single day until the plan is paid off. A short-term plan avoids the setup fee but requires you to pay within 120 days, which limits how much you can spread the payments.
If you set up a plan online through IRS.gov, the setup fee is lower ($31 for direct debit, $225 for other payment methods) than if you call or mail in the request ($225). This is the only place where the IRS rewards you for using their online system.
How paying off early affects interest and penalties
You can pay off a payment plan at any time without penalty. The moment you pay the full remaining balance, interest and the failure-to-pay penalty stop accruing. This is one of the few ways to reduce what you owe beyond the original tax.
If you receive a tax refund in a future year, the IRS will automatically explore it to your payment plan balance, which accelerates payoff and saves you interest. You cannot opt out of this; it is automatic. If you want to keep a refund, you would need to pay off the plan in full before filing that year's return.
Some people use a personal loan or credit card to pay off the IRS plan early if the interest rate on the loan is lower than 8%. This is a personal financial decision, but the math is straightforward: if you can borrow at 5% and the IRS is charging 8%, paying off early saves you money. Just make sure you have the cash flow to handle the new loan payment.
Interest on payment plans versus paying in full
The cost of a payment plan is the interest and penalties that accrue while the balance sits unpaid. A $10,000 tax debt paid in full today costs $10,000. The same debt on a 24-month plan at 8% interest costs roughly $11,000 by the time it is paid off — the extra $1,000 is interest and penalties.
Longer plans cost more in total interest because the balance stays unpaid longer. A 60-month plan on the same $10,000 debt costs roughly $12,000 or more, depending on rate changes during the plan. The IRS offers plans up to 72 months for larger debts, and the interest compounds over the full term.
This is why the IRS prefers you to pay in full or as quickly as possible. If you have any way to pay faster — a bonus, a tax refund from a prior year, a side income — using it to pay down the plan balance saves you money in interest.
Frequently Asked Questions
Can I see how much interest I have already paid on my plan?
Yes. You can view your payment history and account transcript on IRS.gov by logging into your account, or you can call the IRS at 1-800-829-1040 and request a transcript. The transcript shows how much of each payment went to tax, interest, and penalties.
What happens to my interest if the IRS rate drops mid-plan?
Your interest rate drops automatically on the next quarter change date. You do not have to do anything. The lower rate applies only to interest accruing after that date; it does not refund or reduce interest you already paid at the higher rate.
Do I owe interest on the setup fee?
No. The setup fee is a one-time cost, not part of the tax debt. Interest accrues only on the original tax amount and any penalties. The setup fee is either deducted from your first payment or added to your total balance, but it does not earn interest.
If I miss a payment, does the interest keep accruing?
Yes. Interest and the failure-to-pay penalty continue to accrue even if you miss a payment. If you miss a payment, contact the IRS as soon as possible to get back on track. Missing payments can cause the plan to be terminated, and the full remaining balance becomes due when ready.
Is there a way to avoid the failure-to-pay penalty?
No. The 0.5% monthly failure-to-pay penalty accrues on all unpaid tax balances, whether you are on a payment plan or not. It stops only when the tax is paid in full. It is separate from interest and cannot be waived unless the IRS grants relief for reasonable cause, which is rare.