Exact Underpayment Interest Computation?

Forum|Forum|1 year ago
August 12, 2024
1 reply
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This is a nitpicking calculate all the decimal digits kind of question. I'm wondering if anyone out there

can tell me the exact formula for how the IRS calculates interest on underpayments and provides

some numerical test values to be sure they are right.

What I've gathered is how the interest rate comes out quarterly as 3%+fed short term rate. (Reference [1])
and that interest is compounded daily (Reference[2])

That's good enough for an approximation but not an exact computation.
For example one can try to use P(1+r/365)^(number of days)
or P(1+r/366)^(number of days) in a leap year, as a guess, but I have no way of knowing
if this is correct. I can imagine slightly different other formulas as well.

Anyone out there can tell me and prove convincingly that they have it down to the penny?

[1] https://www.irs.gov/payments/quarterly-interest-rates

[2] https://uscode.house.gov/view.xhtml?req=(title:26%20section:6622%20edition:prelim)%20OR%20(granuleid:USC-prelim-title26-section6622)&f=treesort&edition=prelim&num=0&jumpTo=true)

Opus 17

Level 15

I don't have the exact formula, I'm not sure anyone does.

One thing to note is there is also an underpayment penalty of 0.5% per month or partial month. So if the IRS determined that you owed $1000 as of June 15, and you paid June 16, you would be assessed one day of interest but the full penalty. And the interest is compounded on the penalty as well as the balance.

Also, I think the interest rate is variable.

I think the challenge is not the exact formula but how the IRS applies it. For example, suppose you owe $5000 when you file your return and pay in full on April 15, 2024. The IRS wants taxes to be paid in quarterly installments or by withholding, so you technically owed $1250 on the previous April 15 2023, June 15, September 15, and January 15. So you need to take that amount owed from April 16, add the monthly penalty and the daily interest through June 15, then add the new amount owed and keep calculating monthly penalties and daily interest through September 15, then add the new amount for Sept 16, and so on. It's a complicated moving target.

Mike9241

Level 15

there is a penalty for underpaying estimated taxes form 2210 (see form 2210 and the instructions for the computation of this penalty), a penalty of .5%/month for paying after the normal due date. in addition, when paying after the normal due date there is currently an 8% interest charge which is compounded daily. it consists of the federal short-term interest rate of 5% + an added 3%. the rate changes every 3 months

https://www.irs.gov/payments/quarterly-interest-rates

it seems you are asking about the 2210 penalty only

Mike9241