What Is the IRS Interest Rate and Why Does It Matter?

Key Takeaways:

  • The IRS Code Section 6621 allows quarterly review of IRS interest rates.
  • Interest is only calculated on refunds for overpayments more than 45 days late. 
  • QPRTs and CRTs are effective strategies for wealth management in periods of high interest.
  • The IRS announced on February 23, 2022, that interest rates would increase by 1% for the second quarter of 2022.

The Internal Revenue Service (IRS) announced on February 23, 2022, that interest rates would increase for the second quarter of 2022, affecting underpayments and overpayments. The underpayment rates for taxpayers and corporations would be 4% daily compounded rates, and the rate for corporate underpayments exceeding $100,000 would increase to 6%. 

The rate for overpayments, on the other hand, would be 5%, or 4% in the case of a corporation. Corporate overpayments exceeding $10,000 would have a rate of 2.5%. 

The Internal Revenue Code stipulates that the rate of interest is determined quarterly. Taxpayers other than corporations pay the federal short-term rate plus 3% for both over- and underpayment.

For large corporations, overpayments of more than $10,000 result in the federal short-term rate plus 1.5%, while large underpayments are assessed at the federal short-term rate plus 5%.

Understanding IRS Interest Rates and Penalties 

Those individuals and corporations that overpay on the taxes they owe are eligible for a refund. The IRS is generally expected to issue a refund within an allotted 45 days, and if this doesn’t happen, the taxpayer should receive interest on the amount the IRS withheld longer than allowed by law. 

Corporations or individuals who underpay the total amount they owe should pay penalties in addition to the interest on that amount. The longer the taxpayer takes to remit payment, the higher the interest they attract on the amount of taxes they owe and the payable penalty. 

The IRS levies penalties for infractions instead of insufficient tax payments. Penalties are applicable for failure to file or pay taxes, not furnishing required information, inaccurate returns, and so on. 

The date the IRS starts to charge interest depends on the penalty. Interest serves as an incentive for taxpayers to pay the penalty sooner since interest increases the amount you owe until the taxpayer has cleared the due amount. 

Current IRS Interest Rate

How much interest does the IRS currently charge? Before the announcement of the new interest rates, the IRS previously had the following rates in the first quarter:

  • Corporate overpayment – 2%
  • Noncorporate overpayment (for example, individuals) – 3%
  • Underpayment for both corporate and non-corporate – 3%
  • Corporate overpayment of more than $10,000 – 0.5%
  • Large Corporate Underpayment (LCU) – 5%
  • Internal Revenue Code (IRC) – 0% 

Interest accrues on unpaid tax, interest, and penalties until you’ve paid the balance in full. 

Strategies for Wealth Management in the Era of Rising Interest Rates

Interest rates are rising, and there are indicators from the Federal Reserve that more hikes are on the way. How does the change affect wealth management? It may be an excellent time for investors to consider long-term wealth management strategies that work well in a high-interest rate environment. 

Two popular options are the qualified personal residence trust (QPRT) and the charitable remainder trust (CRT). 

Qualified Personal Residence Trust 

A QPRT is an irrevocable trust. It reduces the taxable estate by temporarily transferring your residence into a trust. The home can then be transferred to beneficiaries when the term interest expires. Beneficiaries in most cases are spouses or children, or trusts set up for beneficiaries.

The strategy is an effective estate tax minimization tool that allows you to continue paying the benefit using your home while it’s not part of your estate. You can transfer a limit of two residences to a QPRT, one being the primary residence and the other secondary. 

You can continue to live in the residence after the term interest expires, as long as you pay rent at a fair market value to the remainder beneficiaries. This provides an additional way to transfer wealth since it’s not a gift. 

QPRTs are generally structured to allow tax liabilities to flow back to you as the grantor. The tax you pay goes back to you, and the rental payments are tax-free. 

The initial transfer to the QPRT is a taxable gift of the value of the remainder interest. It’s calculated according to the stipulations set in Section 7520 of the IRS code. The higher the interest rate, the more right you have to use the residence as your own during the term interest. 

Charitable Remainder Trust 

A CRT allows you to fund a trust and receive an annual payment for two years. You can distribute the remaining assets to a designated charity after the trust is terminated. Two types of charity to consider are:

  • Charitable remainder annuity trust (CRAT): Pays a fixed income based on a predetermined percentage of the initial fair market value of the assets gifted to the CRAT. The yearly reimbursement doesn’t change during the charitable remainder annuity trust’s term. 
  • Charitable remainder unitrust (CRUT): CRUT pays a fixed percentage of your income stream based on the balance of the trust assets revealed annually. The annual payment changes annually in the lifespan of the trust term. 

Either of these is a good option, but it’s important to consult a professional to determine which is best for your needs.

Once you create a CRT, you can claim an income tax deduction for the charitable part of the transfer. The charity is entitled to at least 10% of the initial contribution once the trust expires. 

Proper Wealth Management as the IRS Interest Rates Hike 

Underpaying your taxes is stressful, considering the increasing interest rates and penalties, but fortunately, there are some viable options to consider in your wealth management strategy. QPRTs and CRTs are two effective strategies for high-interest periods. 

You also owe it to yourself to speak to a professional in wealth management before implementing any strategy. The professionals at Bogart Wealth can review your tax payment status and advise you on your way forward. Contact us today and schedule a call with our team to get started.

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