Interest is the part of an IRS bill nobody budgets for. You look at a transcript, see the tax you remember owing, and then see a second number that has quietly grown into something larger than the first.
Bankruptcy can deal with that interest. Sometimes it wipes it out completely. Sometimes it only freezes part of it, and the rest is waiting for you on the other side of the case. Knowing which is which is the difference between a fresh start and a nasty surprise.
Where IRS interest comes from
Under IRC § 6601(a), when tax is not paid by the last date prescribed for payment, interest runs from that date until the day it is paid. The rate is the underpayment rate under IRC § 6621(a)(2): the federal short-term rate plus 3 percentage points, reset quarterly. And under IRC § 6622, that interest is compounded daily.
Interest is not a penalty. The IRS does not abate it because you had a hard year. That matters in bankruptcy, because the rules for penalties and the rules for interest are not the same (more on that below).
Interest that built up before you filed
The simple rule: pre-petition interest gets the same treatment as the tax it sits on. The IRS's own manual says so, stating that accrued pre-petition interest on tax gets the same classification as the underlying tax (IRM 5.9.13.19.3).
- If the tax is a priority claim, the interest that accrued on it before filing is part of the priority claim.
- If the tax is old enough to be a general unsecured claim and meets the 3-year, 2-year, and 240-day tests, the interest on it is general unsecured and dischargeable along with it.
- If the tax is secured by a federal tax lien, the interest is part of the secured claim, up to the value of what the lien attaches to.
Interest on penalties is a separate item. The IRS classifies pre-petition interest on a penalty that relates to a priority tax as a general unsecured claim, the same as the penalty itself (IRM 5.9.13.20). If you want the full picture on penalties, read how tax penalties are treated in bankruptcy.
Interest after you file: the estate stops paying it, you may not
The Bankruptcy Code disallows claims for "unmatured interest" under 11 U.S.C. § 502(b)(2). In plain English, interest that had not yet accrued when you filed is not part of the IRS's claim against the bankruptcy estate.
People read that rule and think the meter stopped. It did not. Section 502(b)(2) controls what the estate pays out. It says nothing about what you personally owe after the case if the tax itself is not discharged.
The Supreme Court settled this in Bruning v. United States, 376 U.S. 358 (1964): post-petition interest on a tax debt that is not discharged remains the debtor's personal liability after bankruptcy. The IRS manual follows the same rule, stating that pre-petition and post-petition interest on nondischargeable taxes are nondischargeable, including interest that accrues during a bankruptcy plan (IRM 5.9.17.8).
How it plays out in Chapter 7
Chapter 7 is short, usually a few months from filing to discharge. For the tax years that qualify for discharge, the tax, the pre-petition interest, and any interest that would have accrued are all gone.
For the tax years that do not qualify, nothing about the interest improves. It keeps compounding daily through the case and beyond. Meanwhile, under IRC § 6503(h), the IRS's collection clock is suspended while the IRS is barred from collecting, plus six months. So you can come out of a Chapter 7 owing the same nondischargeable tax, more interest, and with the collection statute pushed back. That is why the year-by-year dischargeability analysis comes first. Run your years through the bankruptcy discharge calculator before you assume anything.
In the rare Chapter 7 case where the estate has a surplus after paying all allowed claims, 11 U.S.C. § 726(a)(5) pays interest at the legal rate from the filing date before anything goes back to the debtor. Most people never see that situation.
How it plays out in Chapter 13
Chapter 13 is where interest gets interesting. Under 11 U.S.C. § 1322(a)(2), the plan must pay priority claims in full, in deferred cash payments. "In full" means the allowed claim, and because § 502(b)(2) disallows unmatured interest, the plan generally does not have to add post-petition interest to an unsecured priority tax claim. That is a real advantage over a payment plan with the IRS, where interest never stops.
But watch the taxes Chapter 13 does not discharge. Section 1328(a)(2) excludes, among others, trust fund taxes under § 507(a)(8)(C) and taxes for unfiled, late, or fraudulent returns under § 523(a)(1)(B) and (C). On those, the IRS manual is blunt: interest that accrues post-petition and during the plan is nondischargeable, and if the plan paid only the pre-petition tax and interest, there will be an interest balance due when the plan ends (IRM 5.9.17.15.1).
The Code gives you a tool for that. Section 1322(b)(10) lets a plan pay post-petition interest on nondischargeable unsecured claims, but only if you have disposable income left after providing for full payment of all allowed claims. If your budget can carry it, paying that interest inside the plan beats facing a bill at discharge. For more on how these claims are scheduled, see paying priority tax claims in a Chapter 13 plan.
Secured tax claims: interest is the price of keeping the property
Secured claims are different. If the IRS filed a notice of federal tax lien before your case, part of its claim may be secured. Under 11 U.S.C. § 1325(a)(5)(B)(ii), a Chapter 13 plan must pay a secured claim its present value, which means interest. Under 11 U.S.C. § 511, the rate for tax claims is the rate under applicable nonbankruptcy law (for federal taxes, the IRC § 6621 rate), fixed as of the calendar month the plan is confirmed.
And if the IRS is oversecured (the property is worth more than the IRS's claim), 11 U.S.C. § 506(b) allows interest on the claim. The IRS manual instructs its employees to claim post-petition interest in that situation (IRM 5.9.13.19.2).
Chapter 11 and Subchapter V
A business or individual in Chapter 11 does not get the Chapter 13 interest break on priority taxes. Under 11 U.S.C. § 1129(a)(9)(C), priority tax claims must be paid in regular cash installments with a total value, as of the plan's effective date, equal to the allowed claim, over no more than five years from the order for relief. "Value" means interest, again at the § 511 rate. See Subchapter V and Chapter 11 for business owners.
Penalties stop in some cases; interest does not
IRC § 6658 blocks certain failure-to-pay additions under §§ 6651, 6654, and 6655 for periods while a bankruptcy case is pending, in specific circumstances. Two catches. First, § 6658(b) does not protect you on taxes withheld or collected from others, like payroll trust fund taxes. Second, § 6658 is about additions to tax. It does not turn off interest.
A quick summary
| Type of tax claim | Pre-petition interest | Post-petition interest |
|---|---|---|
| Dischargeable, general unsecured | Discharged with the tax | Discharged with the tax |
| Priority, paid in full in Chapter 13 | Paid as part of the priority claim | Generally not required by § 1322(a)(2) |
| Nondischargeable (late or unfiled returns, fraud, trust fund) | Survives | Survives and keeps running |
| Secured by a tax lien | Part of the secured claim | Present value interest under § 1325(a)(5) or § 506(b) |
What to do about it
Pull your IRS account transcripts for every year you owe and look at the interest on each year separately. Then sort each year into dischargeable, priority, or nondischargeable. Interest on a dischargeable year is not worth worrying about. Interest on a nondischargeable year should change how you plan the case, and sometimes when you file. For a broader overview of how bankruptcy fits with tax problems, see this guide to bankruptcy for tax problems.
If you want a tax attorney to sort your years and tell you where the interest lands, call my office at (813) 229-7100. Every case turns on its own transcripts and dates; this page is general information, not legal advice for your situation. Interest never sleeps, so neither should your plan.