Internal Revenue Manual - 20.2.6 Methods of Computing Interest

Part 20. Penalty and Interest
Chapter 2. Interest
Section 6. Methods of Computing Interest

20.2.6.1 (03-01-2002)
Method and Rates Used

The methods and rates for computing interest are:
- Prior to February 1, 1980, interest was computed on a year, month, month, day, day (YYMMDD) basis.
- Beginning February 1, 1980, the method was changed to calculate total days times the daily factor.
- On January 1, 1983, the method was changed to daily compounding of interest.
The computation methods used to compute simple interest prior to January 1, 1983, are explained at the back of this chapter. See Exhibit 20.2.6 - 1., Methods of Computing Interest.

20.2.6.2 (03-01-2002)
Compound Interest

Per IRC section 6622(a), the Service is required to compound interest on a daily basis. This results in a daily recalculation of the principal amount plus accrued interest.
- principal amount (P)
- daily interest rate (R)
- number of days (T)
- Interest (I)
The balance (principal amount) on which interest is compounded includes tax, penalties (at the point they become subject to interest), additions to tax and all accrued interest.

20.2.6.3 (03-01-2002)
Forcing Assessment of Interest Accruals

Input TC 290 for a zero amount, the appropriate hold code, and Priority Code 5, on Adjustment Document Code 54 or 47 to force the posting of accruals on an unrestricted tax module.

Caution:

Only use this procedure when necessary, for example:
if the account is being moved to Non Master File, or
a module balance is zero, and interest is accruing on unpaid, accrued interest.
Unrestricted FTP penalty accruals are also forced to post with use of Priority Code 5.

Reminder:

If a module is restricted from computing interest, Master File will not systemically assess interest accruals.

20.2.6.4 (03-01-2002)
Automated Interest Computation Tools

The currently supported interest software are InterestNet by Decision Modeling, Inc. and IDRS Command Codes (e.g., CC COMPA). This software will be used in all training material and exhibits and will be the only software sanctioned for use throughout the Service.
Until InterestNet is available to all interest technicians, the IRS developed software, Total Interest Program System (TIPS), as well as some commercial off the shelf (COTS) software programs, such as "TaxInterest" may be used to manually compute interest. All of these programs provide the same `bottom line' debit or credit interest amount (within pennies) if the module information is input correctly.
- The Total Interest Program System (TIPS) may be used when a module is restricted or conditions exist that prevent systemic calculations by Master File. TIPS computations are transaction code driven to mirror Master File computations.
- The Tax Interest Program is a COTS software program that produces both summary and detailed reports of interest computations.
- The SHARP programmable calculator is a commercial software program that provides interest calculations: e.g., debit, credit, Tax Motivated (120%), Estate Tax (rate depends on date of death of the decedent), Large Corp. (2%), and GATT interest.
- These computation tools are no longer supported by the Service and should be replaced by DMI, when possible.

20.2.6.5 (03-01-2002)
IDRS Computation Tools

IDRS Command Codes (CC) are available for the calculation of interest and are valuable computation tools.
IRM, IDRS Terminal Response, explains INTST, ICOMP, FTPIN, and PICRD and each type of definer used with CC COMPA.

20.2.6.6 (03-01-2002)
CC COMPA and Definers

CC COMPA, with the appropriate definer, may be used to compute interest. The computation is based on the input of a specific amount for a specified period of time.
CC COMPA is designed to be used for only one tax module per input, without gaps or overlaps in the TO and FROM dates. Each line's FROM date must match the previous line's TO date. The principal amount can be positive, negative, or zero. This allows for a continuous CC COMPA input even when a module has intermittent periods of full payment or overpayment. See Exhibit 20.2.6 - 2., Computation Example–CC COMPA.

20.2.6.6.1 (03-01-2002)
CC COMPA

Use CC COMPA with definer C to compute credit interest. See Exhibit 20.2.6 - 3., Computation Example CC COMPAC.

20.2.6.6.2 (03-01-2002)
CC COMPAD

CC COMPA with definer D may be used to request a detailed interest display of the percents, factors, dates and amounts used in the computation. This printout, with an explanation, may be sent to the taxpayer. See Exhibit 20.2.6 - 4., Computation Example–COMPAD.

20.2.6.6.3 (03-01-2002)
CC COMPAM

CC COMPA with definer M is used when requesting multiple independent credit interest computations on the same page.

20.2.6.6.4 (03-01-2002)
CC COMPAP

CC COMPA with definer P is the same as CC COMPA, except the interest is computed at 120% of the regular debit interest rate. CC COMPAP can only be used for dates after December 31, 1984. Line entries must be in strict date order. The Revenue Reconciliation of 1989 repealed the 120% interest provision for returns with due dates (determined without regard to extensions) after December 31, 1989.

Note:

See Chapter 15 of this IRM for instructions on computing Tax Motivated Interest.

20.2.6.6.5 (03-01-2002)
CC COMPAR

CC COMPA with definer R is used when requesting several separate debit interest computations on the same page and each line is to be computed separately. The interest on each line is computed separately and is not considered in the computation of the following line. See Exhibit 20.2.6 - 5., Computation Example–COMPAR.

20.2.6.6.6 (03-01-2002)
CC COMPA4

CC COMPA with definer 4 is used with certain Form 706 Estate Tax returns. CC COMPA4 works in the same manner as CC COMPA, except that the interest rate is always 4%. COMPA2 (2% interest) and COMPA5 (45% of the applicable underpayment rate) are available as of July 1, 1998.

Note:

See Chapter 11 of this IRM for instructions on computing interest on Estate Tax Returns.

20.2.6.6.7 (03-01-2002)
CC INTST

CC INTST is used to determine how debit interest was systemically computed by Master File. It also provides a computation of interest, failure to pay accruals, and a balance due to a specific date. See Exhibit 20.2.6 - 6.Computation Example—CC INTST
CC INTST with definer code D will show a detail of the interest and penalty computations and can be a valuable tool to determine how Master File computations are done.

Caution:

CC INTST does not update restricted interest. If the tax module is restricted, ad manual interest computation must be done.

20.2.6.6.8 (03-01-2002)
CC ICOMP

CC ICOMP with definer F is used to compute payment information on installment agreements. It provides a format to enter the balance due, payment information, and other pertinent data. It is used to determine the:
1. Interest accruals,
2. penalty accruals,
3. total balance due,
4. total number of payments needed to full pay the module, and
5. date and amount of the final payment.
Information from the completed ICOMP display is used to explain penalty and interest accruals on installment agreements, either by phone or correspondence. See Exhibit 20.2.6 - 7., Example of ICOMP.
The ICOMP computation is based on a timely payment of each scheduled installment. Any non-timely or missed payments affects the final payoff amount of the agreement. For this reason, prints of ICOMP should NOT be provided to the taxpayer.

Caution:

CC ICOMP does not update restricted interest. If the tax module is restricted, a manual interest computation must be done.

20.2.6.7 (03-01-2002)
Computer Generated Interest Computations

Master File calculates interest by sorting all money amount transactions in effective date order and computing interest on balances from transaction to transaction (running module balance).
1. When all transactions are sorted and a liability is established, interest is computed on that liability to the date of the next transaction.
2. That transaction amount is added to the unpaid liability plus interest, and interest on this new balance is computed to the next transaction date and so on, through all transactions posted, to the current posting (23C) date.
3. Master File compares the total interest accrued to the net amount of all posted interest transactions in the module and assesses or abates the difference with TC 19X or 33X as appropriate.
4. See LEM 20.2.
The actual computation of debit interest is figured on the balances from the earliest to the latest effective dates and by applying decimal equivalent interest rates based on the months and days elapsed.
1. Interest transactions are ignored in this process.
2. Each successive interest amount added to the accumulation is computed and rounded to the penny.
3. The ending date is either the date to which the module balance goes and remains at a zero or credit balance, or the current posting (23C) date .
In order to properly compute debit interest, the program uses the necessary information from Master File, as well as information that is manually input, such as;
- Transaction Codes and dates.
- Amended Claim Date, to determine if an interest suspension is allowed on taxpayer initiated overpayments.
- Reference Numbers—tell the computer the type of penalty assessed, enabling the system to start interest on the appropriate date. A TC 240 (input without a reference number) accrues interest from the assessment date.
- Waiver/870 Date—on agreed examination cases, tells the computer to suspend interest from the 31st day after the waiver date until the date of assessment.
- Claim Received Date
- Interest Computation Date—on carryback cases and some employment tax cases, tells the computer when to start the interest on the corresponding amounts (e.g., TC 298/299, TC 308/309).
- Payments made by the taxpayer—generally are effective on the date that the payment was received by the Service or bank (lockbox).
If a taxpayer makes full payment of a proposed liability under Revenue Procedure 84–58 (section 4.03), no notice of deficiency is mailed, and the tax is assessed. If a taxpayer makes a partial payment of tax indicating agreement to part of a proposed liability, the Service may assess that tax without following deficiency procedures. The request to designate all or part of the payment to interest is honored if one of the following conditions is met:
1. The taxpayer agrees to assessment and collection of the liability by executing a waiver of restrictions; or
2. The taxpayer pays the underlying tax with respect to the amount to be designated as interest and the amount designated does not exceed the amount of interest that has accrued on the tax being paid.
After an interest computation is completed, conditions in the module may change, causing a recalculation of the module including interest. This can be caused by a transaction posting with an earlier effective date than the date to which interest was previously computed. The purpose of the interest adjustment is to ensure that the proper amount is posted to the module after taking into consideration all outstanding balances, late posting credits, and subsequent assessments.

20.2.6.7.1 (03-01-2002)
Payment Allocation

Payments are generally applied in the following order:
1. tax
2. tax motivated transaction (TMT) tax
3. penalties
4. non-TMT interest
5. TMT interest
A payment previously used to pay assessed interest may at a later date be used to pay an additional tax assessment (for interest purposes only).

Caution:

Payments with effective dates before December 31, 1982 should not be reallocated when computing interest.Interest on any subsequent assessment must be manually computed if a previous interest assessment was paid with payments having effective dates prior to December 31, 1982.
Since payments are applied to liabilities in effective date order, undesignated payments may be applied to certain penalties before tax.

Example:

Penalty assessments that accrue interest from the due date of the return would be paid before a tax liability from a math error on a return prepared by a Service employee. Interest accrues on a math error adjustment from 30 days past the notice date.
See LEM 20.2.

20.2.6.8 (03-01-2002)
Steps to Manually Compute Interest

To compute interest to a specific date:

If	Then
The account is not restricted from computing interest	Use CC INTST or CC FTPIN
The account is restricted from computing interest, or module conditions exist that prevent systemic calculations	Manually Compute

Use the following process to determine the net amount of interest to be assessed or abated. This process allows for consideration to any interest free periods and allows comparison of the adjusted amount to interest already assessed.
1. Using a current TXMOD or Master File transcript, compute a running module balance on the entire tax module.
2. Enter debits and credits on the appropriate dates.
3. Suspend and resume interest (on a specific amount if necessary) for waiver/suspension periods.
4. Compare the amount of interest assessed on the account to your interest computation to determine the interest assessment (TC 340) or abatement (TC 341).
5. Balance by comparing the module balance plus/minus your adjustment with the balance of interest and principal on your computation. If the balances are not the same, go through your computation to determine if there is an error in your entries.
  
  Note:
  
  Always balance your computation with the tax module balance plus/minus your adjustment.