How does the IRS calculate interest on underpayments and compound interest rules?

1. How the IRS sets the numerical rate — the quarterly formula

Congress gave the IRS authority under IRC §6621 to set interest rates each quarter by reference to the federal short‑term rate; for most taxpayers the underpayment rate equals the federal short‑term rate plus 3 percentage points, while large corporate underpayments use the short‑term rate plus 5 points ^{[4] [2]}. The IRS publishes revenue rulings and Internal Revenue Bulletins each quarter (for example Revenue Ruling/IRB notices showing 7% and 9% figures for 2025 quarters) to announce the numerical rates used to compute interest ^{[1] [4]}.

2. Daily compounding — what “compound interest” means for tax debt

Federal law requires that interest on tax underpayments and overpayments be compounded daily; that is, interest is assessed on the prior day’s balance including any interest that has already accrued ^{[5] [3]}. The IRS explains that daily compounding is used because section 6622 subjects the statutory rate to daily compounding and Notice 88‑59 directed use of the federal short‑term rate based on daily compounding ^{[3] [6]}.

3. Practical effect: how interest actually accrues day to day

Because the IRS compounds daily, you compute interest by applying a daily factor (annual rate divided by 365 or per IRS tables) to the outstanding balance each day and adding it to the balance — the next day’s interest is then calculated on that slightly larger balance ^{[5] [6]}. The IRS publishes “interest factors for daily compound interest” and tables for the daily factors at the applicable annual rates to help manual or system calculations ^[6].

4. Different rates and special corporate rules

Rates differ for non‑corporate taxpayers and corporations: overpayment and underpayment rates for non‑corporations are the federal short‑term rate plus 3 points; corporate overpayment rates may be lower (short‑term plus 2 points) and large corporate underpayments carry a higher (short‑term plus 5 points) rate; special thresholds (e.g., corporate overpayments >$10,000 or LCUs) trigger different sub‑rates that the IRS defines in its guidance ^{[2] [4] [1]}.

5. Timing: when interest begins and stops

Interest generally accrues from the original due date of the return (without extensions) until the date of full payment; the IRS’s taxpayer guidance reiterates that interest accrues on unpaid tax from the return due date until payment in full ^[7]. The IRM and other IRS guidance also note that interest may be assessed and collected at any time during the statutory collection period and that interest itself is treated like tax for assessment and collection purposes ^[8].

6. Manuals, tables and where to find calculation mechanics

The IRS Issue Management guidance and Internal Revenue Bulletins (Revenue Rulings) publish the numerical quarterly rates and supply tables/factors for daily compounding; the IRM (IRM 20.2.x) contains operational rules and procedures for manual calculation and verification of interest on tax modules ^{[5] [6] [8]}. Revenue Rulings and IRBs (e.g., those cited for 2025 quarters) include the precise tables and examples for applying daily compounding factors ^{[1] [6]}.

7. Limitations, edge cases and what available sources do not mention

Available sources explain the statutory framework, quarterly rates, daily compounding requirement, and corporate special rules, but detailed worked numerical examples for a multi‑quarter debt across changing rates are provided only in IRS tables or the IRM rather than in the newsroom summaries ^{[6] [8]}. Available sources do not mention personalized calculation tools or third‑party calculators except that IRS publications include daily factors — practitioners commonly use IRS tables or software (not found in current reporting) ^[6].

8. Competing perspectives and implicit agendas

IRS materials and Federal Register notices present the rules formally and emphasize legal formulas and tables ^{[6] [9]}. Tax preparer outlets (e.g., TurboTax, CPA advisories) interpret those rates for taxpayers and give headline rates (e.g., “7% for individuals”), which is useful but can oversimplify how daily compounding and corporate exceptions change calculations ^{[10] [11]}. The IRS’s quarterly releases have an implicit agenda to present administrable, uniform rules; industry write‑ups aim to highlight taxpayer impact and simplifications for readers ^{[2] [11]}.

If you want, I can: (a) show a short numerical example that walks through daily compounding for a single month at a 7% annual rate using IRS daily factors (sources above provide the factors in the IRB/tables referenced), or (b) point to the exact IRS Revenue Ruling / IRM page and table you should use for a manual calculation ^{[1] [8]}.