- 1). Establish the interest rate that will be charged on your unpaid federal income tax. If you filed on time but did not pay the tax on time, the interest rate is equal to the short-term federal rate plus 3 percent. The interest rate assessed is set quarterly based on changes in the short-term rate. That means your rate for one period could be different from the rate for another period of time. If you did not file on time, the rate is 5 percent per month for up to five months.
- 2). Determine the principal amount (the original amount owed) and the number of days your tax is past due. Use these figures to calculate penalty interest.
- 3). Multiply the appropriate rate from Step 1 by the principal. The result is the interest assessed for the first day the tax was past due.
- 4). Add the interest from Step 3 to the principal. This is the new principal amount. Use this figure to repeat Step 3. Repeat Steps 3 and 4 once for each day the tax has been overdue. For example, repeat the steps five times if the tax is five days past due and 45 times if the tax is 45 days past due.
- 5). Write down the principal amount after all the compounded interest has been calculated.
- 6). Multiply the principal from Step 5 by 0.5 percent, or one-half percent, for each month the tax has been overdue. For four months, for example, you would multiply by 2 percent. The result is the amount of your penalty. It also must be paid, but it is not factored into the compounding interest you have been assessed. Instead, the penalty is tacked on after the principal amount is calculated. If the IRS issues a notice to levy, multiply by 1 percent for each month after the levy notice is issued. The maximum is 25 percent. Write down the resulting figure, and add it to the principal. This is the total amount you owe.
- 7). Subtract the original tax liability amount from the figure determined in Step 6. This establishes the full amount of the penalty you have been assessed up to the current date. Essentially, it is the difference between the amount you owe at a given moment and the amount you would have needed to pay if you had paid the tax on time.
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