- 20.2.6.1 Method and Rates Used
- 20.2.6.2 Compound Interest
- 20.2.6.3 Assessment of Interest Accruals
- 20.2.6.4 Interest Computation Tools
- 20.2.6.5 Computer Generated Interest Computations
- 20.2.6.6 Steps to Manually Compute Interest
- 20.2.6.7 Summary
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The methods and rates for computing interest are:
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Prior to February 1, 1980, interest was computed on a Year, Year, Month, Month, Day, Day (YYMMDD) basis.
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Beginning February 1, 1980, the method changed to calculate total days times the daily factor.
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On January 1, 1983, the method changed to daily compounding of interest.
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The Service is required to compound interest on a daily basis per IRC section 6622(a). This results in a daily recalculation of the principal amount plus accrued interest.
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principal amount (P)
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daily interest rate (R)
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number of days (T)
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Interest (I)
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The balance (principal amount) on which interest is compounded includes tax, penalties (at the point they become subject to interest per IRM IRM 20.2.5.3 ), additions to tax and all accrued interest.
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The formula to compute interest is as follows: Interest equals principal times the rate (I = P x R.) The interest plus principal equals the new principal ( I + P = the new P). This procedure is continued over the number of days (T) in the interest computation period.
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Interest will continue to accrue until the liability (tax, penalties, additions to tax and/or interest) is fully paid. Interest accruals are not assessed (recorded) on the transcript (Command Code (CC) TXMOD/IMFOL/BMFOL) except when one of the following conditions occur;
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input of an adjustment (e.g. TC 29X or TC 30X), or
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posted payment is in excess of tax and/or penalties, or
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input of a TC 290 for zero ($.00) with Priority Code 5.
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The input of TC 290 for a zero amount, Priority Code 5, with the appropriate hold code on an unrestricted tax module will post any accrual of interest. If adjusting with Document Code 54, use Hold Code 0, so that notices will go out.
Caution:
Only use this procedure when necessary, for example:
if an account is being moved to Non-Master File or MFT 31, or
a module balance is zero, and interest is accruing on unpaid, accrued interest. -
Unrestricted Failure to Pay (FTP) penalty accruals will also post with the input of TC 290 for zero, with Priority Code 5.
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If you want to stop accruals because it is below tolerance (see IRM 21.5.2.4.8.3), then input a TC 290, 340, and 270 for zero amounts.
Reminder:
If a module is restricted from computing interest, Master File will not systemically assess interest accruals. Refer to Section 8 of Document 6209, IRS Processing Codes and Information, for an explanation of conditions that restrict systemic interest computation.
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IDRS Command Codes (e.g., CC COMPA, INTST ) are used for simple interest computations. In addition to these command codes, the Service supports the use of a Commercial Off The Shelf (COTS) software program called InterestNet, developed by Decision Modeling, Inc. Internally known as ACT (Automated Computational Tool), it is used for more complex interest computations. This software is available to all employees, particularly those involved with the calculation of restricted interest. IRM20.2.8.6 summarizes some of the reasons interest may need to be restricted on a tax module.
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See IRM 2.3, IDRS Terminal Response, for an explanation of CC's FTPIN, ICOMP, INTST, and PICRD and each type of definer used with CC COMPA.
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CAUTION:CC INTST does not update restricted interest. If the tax module is restricted, a manual interest computation must be done. Occasionally, CC INTST does not match the Master File interest and/or penalty computation. Before CC INTST results are used, they should be cross-referenced against the Master File computation by comparing total penalty and interest displayed by the applicable CFOL command code to total penalty and interest computed by CC INTST using the same interest date(s) as displayed by the CFOL command code.
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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).
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When all transactions are sorted and a liability is established, interest is computed on that liability to the date of the next transaction.
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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.
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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.
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See LEM 20.2.
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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.
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Interest transactions are ignored in this process.
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Each successive interest amount added to the accumulation is computed and rounded to the penny.
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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 .
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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;
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Transaction Codes and dates.
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Amended Claim Date, to determine if a credit interest suspension period is applicable on taxpayer initiated overpayments.
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Reference Numbers—tell the computer the type of adjustments to be assessed, enabling the system to start interest on the appropriate date. Penalty Reference Numbers (PRN) are used specifically for certain types of penalties for the same reason. If a TC 240 without a PRN is input, then interest accrues from the assessment date.
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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 on that deficiency amount.
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Transaction Code (TC) 971/Action Code 064 - will tell the computer to suspend interest after 18/36 months from the timely filed return due date or return received date, and then end the interest suspension period 21 days from the TC 971/064 transaction date, (unless the interest requires restriction). On November 26, 2007, the 18 months notification period changed to 36 months for notices issued after this date. See IRM 20.2.7.6 IRM 4.31.6.2.5.4for clarification of notification dates and other IRC 6404(g) rules.
Note:
Restriction of interest may be required if posting a 10/04/2004 notice date.
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Claim Received Date—date claim received by the Service.
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Interest Computation Date—on carryback and some employment tax adjustments, tells the computer when to start the interest on the corresponding tax amounts (e.g., TC 298/299, TC 308/309).
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Payments made by the taxpayer—generally are effective on the date that the payment was received by the Service or bank (lockbox). Payments received within a notice grace period are applied as of the notice date to eliminate additional debit interest accruals. See LEM 20.2.
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If a taxpayer makes full payment of a proposed liability under Revenue Procedure 2005–18 (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 up to the amount paid without following deficiency procedures (see IRM 4.4.24"Payments and Remittances)" . The request to designate all or part of the payment to interest is honored if one of the following conditions is met:
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The taxpayer agrees to assessment and collection of the liability by executing a waiver of restrictions; or
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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.
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After an interest computation is completed, conditions in the module may change, causing a recalculation of interest on the module. 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.
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Payments are generally applied in the following order:
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Tax
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Tax Motivated Transaction (TMT) tax
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Penalties and fees
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Non-TMT interest
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TMT interest
A payment previously used to pay assessed penalty and/or interest should be reallocated if at a later date there is an additional tax assessment (for interest purposes only). Master File will not always reallocate payments, so the module may need to be restricted, especially if it is a large amount.
For example: Payment of $6,000 paid tax of $5,000, penalties of $800 and interest of $200. Later, there is an audit and the taxpayer agrees to $2,000 in additional tax. The $1,000 previously applied to penalties and interest should be reallocated to pay the new deficiency.
However, if the taxpayer previously specifically allocated a payment to interest, then it remains allocated to interest.
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.
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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 starting from 30 days past the notice date.
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See LEM 20.2.
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To compute interest to a specific date after a tax underpayment and penalties have posted:
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 of any interest free-periods and allows comparison of the adjusted amount to interest already assessed. Use either CC COMPA or the ACT/DMI program.
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Using a current TXMOD or Master File transcript, compute a running module balance on the entire tax module.
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Enter debits and credits on the appropriate dates.
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Suspend and resume interest (on a specific amount if necessary) for waiver/suspension periods.
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Compare the amount of interest assessed on the module to your interest computation to determine the interest assessment (TC 340) or abatement (TC 341). Compare 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.
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PL 97–248 provided that interest will be compounded daily, effective 1–1–1983. It also provided for semi-annual redetermination of the interest rate, with any new rates effective January 1 or July 1. For subsequent interest rates check the IRWeb.
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Effective 1–1–1987, the interest rate is redetermined quarterly. The rate of interest allowable (credit interest) is 1% lower than the rate of interest assessed (debit interest). Effective 1–1–2000, the interest rates for individual taxpayers became equal for both debit and credit interest.