Smart Tax Planning

Uncle Sam is paying 5% interest on your late tax refund. And yes, it's taxable

Key Points
  • The IRS is issuing tax refunds at a slower pace compared to last year as filers wait to submit returns and the taxman’s workforce returns to the office in waves.
  • Those who receive a refund after April 15 will also receive interest — as much as 5% — on the amount they get back from the government. You still have to file by July 15.
  • This interest is taxable, and you may owe money on it next spring.
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Forget high-interest savings accounts. The IRS is crediting up to 5% interest on late tax refunds.

The government agency announced it would grant interest on tax refunds that are issued after April 15 – the original due date for 2019 federal income tax returns.

Bear in mind that the IRS has pushed out the new due date for returns to July 15. The interest applies to returns filed by then.

The interest is a sweetener for individuals who have been waiting months for a tax refund — because they either filed paper returns or require additional verification with the taxman — and have been stymied by the agency's gradual return to operations amid the  coronavirus outbreak.

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Interest rates offered by the IRS just about beat any savings account.

The agency adjusts the rate every quarter. For the second quarter ending on June 30, it's crediting 5% per year, compounded daily.

Meanwhile, the interest rate for the third quarter, ending Sept. 30, is 3%.

In comparison, top high-yielding savings accounts are currently earning about 1.35%, according to Bankrate.com.

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Of course, there's a catch: Any interest you receive from the IRS is going to be subject to taxes when you file your 2020 return next spring.

"This isn't free money," said Dan Herron, CPA and principal at Elemental Wealth Advisors in San Luis Obispo, California. "You're going to get a Form 1099-INT from the IRS in 2020."

Be sure to set aside a few dollars to cover the tax bill on the interest.

Need the cash now? Don't wait

cmannphoto | Getty Images

Tax refunds often amount to a hefty chunk of change. The average refund issued as of June 12 was $2,767.

In comparison, the IRS has been delivering pandemic stimulus checks of up to $1,200 per individual, plus $500 for each qualifying child, since Congress passed the CARES Act in March.

Though it may be tempting to wait and allow your interest to accumulate, you should get your return in — preferably via e-file — as early as you can, if you need the money.

"It's great that you're getting 5% on your refund, but at the end of the day, the refund is more important than the interest," said Herron. "Any money you can sock away is advantageous."