The 0.25% Failure-to-Pay Rate During an Installment Agreement

Most people know an installment agreement stops levies. Fewer know it also cuts the failure-to-pay penalty in half. Fewer still know the cut only works if the return was filed on time. That last condition is where the money is.

The statute

IRC 6651(h) says that for an individual who files the return on or before the due date (including extensions), the failure-to-pay rates in IRC 6651(a)(2) and (a)(3) are applied by substituting 0.25 percent for 0.5 percent for any month during which an installment agreement under IRC 6159 is in effect for that tax.

Everything else about the penalty stays the same. It is still charged on the unpaid tax at the start of each month. It is still capped at 25 percent of the tax. It just accrues at half speed. The base mechanics are in the failure-to-pay guide.

Who qualifies

IRM 20.1.2.3.8.1.2 lists the two requirements, and both must be met:

1. The taxpayer is an individual. Not a corporation, partnership, trust, or exempt organization. The IRM notes the reduced rate can apply to an individual's income, employment, and excise tax, and that decedents' estates and generation-skipping tax returns also qualify.
2. The return was filed on time, including extensions. File late and the reduced rate is gone for that return, no matter how faithfully you pay the agreement.

On the IRS side, the month an agreement goes into effect is marked on the transcript with transaction code 971, action code 063. The IRM is explicit that the code alone does not prove you get the reduced rate. Both conditions still have to be met.

When the reduced rate starts and stops

The 0.25 percent rate applies to penalty months during which the agreement is in effect. Months before the agreement are charged at 0.5 percent (or 1 percent, if a levy notice already raised the rate).

Under IRM 20.1.2.3.8.1.2, the reduced rate ends after the month in which the agreement terminates. An agreement is treated as terminated on default or full payment, 10 days after a notice of intent to levy, or the day of a jeopardy demand. The IRM also lists conditions that cause termination: missed payments, a new assessment not included in the agreement, the account going currently not collectible, or a bankruptcy filing. After termination, the rate reverts to whatever it was before.

Worked example: two years of payments

Say you file your 2025 return on time, on April 15, 2026, showing $24,000 due. You set up an installment agreement that is in effect starting with the penalty month beginning June 16, 2026. You pay $1,000 a month on the 28th, starting June 28, 2026. Each payment is applied to tax first for penalty purposes (IRM 20.1.2.3.8.2), so the tax is paid off with the 24th payment on May 28, 2028.

The savings equal exactly half of the penalty for the months the agreement was in effect. On a bigger balance or a longer agreement, the number grows. On a $60,000 balance paid over six years, the difference runs into the thousands.

The late filer comparison

Now run the same facts, except the return was filed three months late in July 2026. The taxpayer still sets up the agreement and pays $1,000 a month. The failure-to-pay rate stays at 0.5 percent the whole time, so the penalty is $1,740 instead of $990. And there is a failure-to-file penalty on top: $24,000 x 4.5 percent net x 3 months, or $3,240 (see the overlap guide).

Three months of procrastination on the return cost $3,990 in penalties that the on-time filer never paid. Same tax. Same payments. Different envelope date.

Interest does not get a discount

IRC 6601(b)(1) says the last date prescribed for payment is determined without regard to any installment agreement. So interest runs from the original due date on every unpaid dollar of tax, compounded daily under IRC 6622, at the quarterly underpayment rate. For 2026 that was 7 percent in the first quarter, 6 percent in the second, and 7 percent in the third and fourth quarters (Rev. Rul. 2026-15). See IRS interest rates by quarter.

Because payments go to tax first for penalty computation, interest and penalties tend to be the last things paid off. The tax balance hitting zero does not mean the account is clear. Expect a tail of accrued interest and penalty at the end of the agreement.

The 25 percent cap still applies

At 0.25 percent per month, a balance that never goes down takes 100 months to reach the 25 percent cap. Most agreements end long before that. The cap is computed in the aggregate, so months at 0.5 percent before the agreement count toward the same 25 percent.

What this means in practice

• File every return on time, even when you know you cannot pay. Filing on time is the gate to the reduced rate.
• Get the agreement in place early. Every month at 0.5 percent before it starts is a month you cannot get back at 0.25 percent.
• Keep current-year taxes paid. A new unpaid assessment can terminate the agreement and end the reduced rate.
• Respond to any notice of intent to levy before the 10-day mark. A levy notice can end the reduced rate and trigger the 1 percent rate under IRC 6651(d).

For the choices between types of agreements, see the IRS Installment Agreement Guide.

Worked example: the agreement ends early

Go back to the $24,000 example and suppose the agreement terminates after month 14 because next year's tax was assessed and not built into the plan. Under IRM 20.1.2.3.8.1.2, the reduced rate stops after the month of termination and the rate reverts to 0.5 percent. Assume, for the arithmetic, that the taxpayer keeps sending $1,000 a month anyway.

From month 15 through month 26, the unpaid tax at the start of each month runs from $12,000 down to $1,000. Those balances add up to $78,000. The difference between 0.5 percent and 0.25 percent on $78,000 is 0.25 percent, or $195. So the default costs $195 in extra failure-to-pay penalty, even with every payment made on time, before counting the risk that a levy notice pushes the rate to 1 percent.

The fix is usually simple: pay the new year's tax or ask the IRS to add it to the agreement before the default becomes a termination. Sole proprietors should note that the reduced rate can also apply to employment tax they owe as individuals, per IRM 20.1.2.3.8.1.2, so the same reasoning applies to a payroll balance on a sole proprietorship's account.

To check that the reduced rate was applied, compare the failure-to-pay amounts on successive notices. Once the agreement is in effect, the monthly increase in the penalty should be about one-quarter of one percent of the unpaid tax, not one-half. If it is not, confirm that the return was filed on time, that the agreement was actually in effect for those months, and that no levy notice ended it.

Finally, the reduced rate does not change the 25 percent ceiling or interest. It only slows the penalty. For a taxpayer who will pay over many years, that slower climb compounds into real savings.

The bottom line

The 0.25 percent rate is a reward for doing one thing right: filing on time. It halves the failure-to-pay penalty while an installment agreement is in effect. It does nothing for interest, and it disappears the moment the agreement defaults. If you are setting up a plan, make sure the math reflects the rate you earned.