What is the Penalty for Tax Overpayment?

by Michael Marz

The Internal Revenue Service is required to charge interest on your tax bill that remains unpaid after the filing deadline until the taxes are paid in full. No penalty exists for overpaying your taxes since it means you've fully complied with the law by bringing your tax liability down to zero. However, the IRS may owe you interest on tax overpayments.

What Are Tax Overpayments

The IRS doesn't use the term “tax overpayment” loosely, as it only results in specific situations. An overpayment may occur when the agency make an assessment in error that's not caught until after you make payment. Tax overpayments can also occur when the IRS pursues collection actions against you after the limitations period expires -- meaning you made the payment when you no longer had a legal obligation to. Other common causes of tax overpayments include excessive withholding by your employer, writing a check to the IRS for more than you're required to pay, and when you report a refundable credit on your return. A refundable credit is treated as a payment of tax that can provide you with a refund if it's greater than the tax you owe with the return.

Interest Rate on Overpayments

Overpayments of tax accrue interest at the same rate charged by the IRS for tax underpayments. The applicable interest rate is equal to the federal short-term rate that's set by the government in the first month of each calendar quarter, plus three percentage points. For corporate tax overpayments, however, the IRS increases the short-term rate by two percentage points rather than three.

How Long Interest Accrues

Interest begins to accrue on your tax overpayment no earlier than the due date of your return. For example, if your employer withheld money from your paychecks during 2011 for your 2011 tax liability -- for which the return was due on April 15, 2012 -- all withholding is treated as paid on April 15, 2012. As a result, interest doesn't start accruing until April 15, 2012. The date overpayment interest stops accruing, however, depends on whether you take the interest as a credit towards the following year's taxes or request a refund when you file the return. If taken as a credit, interest accrues until the filing deadline for the tax year the credit applies to. In the above example, the interest will offset the tax you owe in the 2012 tax year and the interest would've stopped accruing on the April 15, 2013 filing deadline. When you request a refund, the interest stops accruing within the 30-day period immediately prior to the date the refund is paid.

When Overpayment Interest is Disallowed

You won't receive a payment or credit towards future tax bills for overpayment interest when you request a refund and it's paid within 45 days after the filing deadline -- regardless of whether you actually file long before the deadline or on April 15. And if you file your return late, the IRS disallows the interest if it pays you the refund within 45 days of the day you actually file.

About the Author

Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.