IRS Penalty & Interest
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The IRS assesses two main types of penalties for late or unfiled tax returns: the Failure-to-File Penalty and the Failure-to-Pay Penalty. Understanding how these work is key to managing your tax debt.

How interest is charged on top

Interest is separate from the penalties and runs on a different rule. The IRS states that interest accrues on any unpaid tax, penalties and interest until the balance is paid in full, and that the rate it charges is compounded daily — assessed, in its words, on the previous day’s balance plus the interest.

The rate is not fixed. The IRS sets it quarterly as the federal short-term rate plus 3 percentage points for standard underpayments, and states that changes to the rate do not affect the rate charged for prior quarters or years. So a balance that has been outstanding for two years has accrued at several different rates, each applying to its own quarter.

One consequence worth knowing: because interest is charged on penalties as well as on the tax, reducing a penalty reduces the interest that was running on it. The IRS states it will automatically reduce or remove the interest related to a penalty when that penalty is reduced or removed.

Administrative penalty relief

The IRS now uses Automatic Exemption from Penalty (AEP) for eligible 2025 tax-year returns, 2026 quarterly returns, and future periods. It applies the relief during processing without a request. First Time Abate remains relevant for earlier eligible periods and cases not considered for AEP. Both use a compliance-history test:

• The same return type was filed on time for the prior three years, or 12 consecutive quarters for quarterly filers
• No penalty other than an estimated-tax penalty was assessed in that period, or an assessed penalty was removed for reasonable cause or IRS error

The IRS lists failure to file, failure to pay, and failure to deposit among the penalties eligible for administrative relief. Whether the conditions are met is determined from IRS account records.