What Keeps Growing During an IRS Payment Plan: Interest and the Quarter-Percent Penalty

The most common misunderstanding about IRS payment plans is that the balance freezes once you sign up. It does not. Treas. Reg. 301.6159-1(c)(1)(ii) says it in one line: the acceptance of an installment agreement does not reduce the amount of taxes, interest or penalties owed. The same sentence adds a parenthetical that matters: penalties may continue to accrue at a reduced rate under section 6651(h).

Two things keep growing while you pay. Here is how each one works.

Interest: the rate the IRS charges everyone

Interest on unpaid tax runs at the federal underpayment rate under IRC 6621, which for individuals is the federal short-term rate plus 3 percentage points, reset each quarter. For October 1 through December 31, 2026, the IRS announced in news release IR-2026-98 and Rev. Rul. 2026-15 that the rate is 7 percent a year, compounded daily.

A payment plan does not change the rate and does not stop interest. Treas. Reg. 301.6159-1(j) states that the last day prescribed for payment is determined without regard to any installment agreement, including for purposes of computing penalties and interest. Interest runs from the original due date of the return until the balance is paid.

Interest also runs on penalties. That is the compounding effect people feel over a long plan: the penalty accrues, and then interest accrues on the penalty.

The failure-to-pay penalty: three possible rates

The penalty for not paying is in IRC 6651. The standard rate under subsections (a)(2) and (a)(3) is 0.5 percent of the unpaid tax for each month or part of a month, up to 25 percent in total. Two other subsections move that rate.

• Up to 1 percent. Under IRC 6651(d), the rate doubles to 1 percent a month beginning 10 days after the IRS issues a notice of intent to levy under IRC 6331(d), or on the day it gives notice and demand for immediate payment in jeopardy situations.
• Down to 0.25 percent. Under IRC 6651(h), for an individual who filed the return on or before its due date, including extensions, the rate is 0.25 percent for any month during which an installment agreement under section 6159 is in effect for that tax.

Who gets the quarter-percent rate

The statute has two conditions: you are an individual, and you filed the return on time. IRM 5.14.1.2 lists the conditions the IRS applies when it codes an account for the reduced rate:

• The installment agreement was entered on or after January 1, 2000.
• The balance is owed by an individual, whether it arises from income, employment or excise tax returns.
• The return was filed on time, including extensions.
• No notice of intent to levy that raised the rate to 1 percent was sent; the IRM names CP 504, LT11 and Letter 1058.

That last condition is worth reading twice. Under the IRM's coding rules, the reduced rate depends on the account not already carrying the levy-notice increase. Setting up a plan before the collection notices escalate protects more than your bank account.

Two other limits. The reduced rate does not apply to a short-term payment plan, because a short-term plan is not a section 6159 agreement; IRM 5.19.1.6.3 says so directly. See short-term payment plans. And if the agreement is terminated, the rate goes back to 0.5 percent. IRM 5.14.1.2 notes the penalty rate is not recalculated for the months the agreement was active, so the months you spent in a plan keep their lower rate.

Why payment order helps you

The failure-to-pay penalty is a percentage of unpaid tax, not of the total balance. And payments under an installment agreement are applied to tax first, then penalty, then interest, according to IRM 5.14.1.2. The campus procedures in IRM 5.19.1.6.4.16 describe the same order, oldest assessment first, after the user fee.

Put those together and every payment shrinks the base the penalty is calculated on. A plan that pays aggressively in the early years cuts the penalty faster than its share of the balance would suggest. The payment plan calculator models that order if you enter the tax portion of your balance.

What a long plan really costs

Take a $45,000 balance, all tax, owed by someone who filed on time and has a plan in effect. Holding the 7 percent fourth quarter 2026 rate steady and applying the 0.25 percent penalty, paying it off in 72 months takes roughly $816 a month, and about $13,750 of interest and penalty accrues along the way. Stretching the same balance to 108 months drops the payment to roughly $609, but the added interest and penalty climbs to about $20,800.

Those are estimates. Rates change quarterly, penalties already on the account change the result, and the IRS uses its own calculator. The pattern is what matters: a longer plan costs less each month and more overall. Pay what you can comfortably sustain, and pay extra whenever you can. The IRM reminds employees to tell taxpayers that extra or higher payments can be accepted at any time.

Businesses do not get the quarter rate

IRC 6651(h) is written for an individual. A corporation or partnership on a payment plan keeps paying the failure-to-pay penalty at the standard rate, or 1 percent a month after a notice of intent to levy. The IRM's coding rules make one distinction worth knowing: the reduced rate applies to balances due from an individual whether they arise on income, employment or excise tax returns, so a sole proprietor with employment taxes can qualify, while the corporation next door cannot.

Interest is also higher for large corporate balances. For the fourth quarter of 2026, the IRS set the rate on large corporate underpayments, those over $100,000, at 9 percent, two points above the 7 percent rate that applies to individuals and to other underpayments. If you run a business that owes, the cost of time is steeper, and the case for paying the plan down faster is stronger. See IRS payment plans for businesses.

Can the penalty be removed?

Sometimes. Failure-to-pay penalties can be abated for reasonable cause under IRC 6651(a), and the IRS has an administrative first-time abatement policy that, according to its penalty relief page reviewed July 14, 2026, covers failure-to-pay penalties when the same type of return was filed on time for the prior three years and no other penalties were assessed in that period, apart from exceptions such as the estimated tax penalty. Requesting abatement does not interfere with a payment plan; the two can run side by side, and any penalty removed reduces the balance the plan has to pay. My firm's main site has an overview of IRS penalty abatement.

Interest generally cannot be abated just because it is large. It is the price of time. The fastest way to reduce it is to shorten the time.

There is a sequencing point here. If a penalty is abated after you have paid it through the plan, the abated amount is credited back to your account and reduces what remains. If the balance is already paid, the credit can produce a refund, subject to the refund statute of limitations. Either way, the plan and the abatement request do not have to wait on each other.

Keep the lower rate

• File every return on time, even if you cannot pay. The quarter-percent rate requires a timely return, and a late return adds a failure-to-file penalty under IRC 6651(a)(1) that can reach 25 percent on its own.
• Set up the plan early, before a notice of intent to levy pushes the rate to 1 percent.
• Pay extra when you can. Because payments go to tax first, every extra dollar shrinks the base the penalty is charged on.
• Do not let the plan default. A termination puts the rate back to 0.5 percent going forward. See what a CP 523 default notice means.