Interest charged by the IRS on tax penalties is not tax deductible for individual taxpayers. Federal law treats it as personal interest and bars the deduction outright, no matter whether the underlying tax came from wages, self-employment, or investment income. The one meaningful exception runs to C corporations, which generally can deduct interest on their own federal tax deficiencies.1Office of the Law Revision Counsel. 26 USC 163 – Interest
The Statute That Shuts the Door for Individuals
IRC Section 163(h) says that for any taxpayer other than a corporation, no deduction is allowed for personal interest. The statute then defines personal interest as any interest that doesn’t fall into one of six narrow categories: trade or business debt, investment interest, passive activity interest, qualified mortgage interest, certain estate tax interest, and student loan interest.1Office of the Law Revision Counsel. 26 USC 163 – Interest
Interest on an IRS penalty doesn’t fit any of those categories. It isn’t tied to a business loan, a mortgage, or an investment. It’s a charge for money owed to the government that wasn’t paid on time. That makes it personal interest by default, and personal interest is non-deductible. You can’t claim it on Schedule A, offset it against business income on Schedule C, or deduct it anywhere else on Form 1040.
This is where taxpayers often get tripped up. Even if the underlying deficiency came from self-employment income or a sole proprietorship, the interest on the resulting penalty is still personal interest. The classification follows the taxpayer, not the income source. A freelancer who underpaid estimated taxes on Schedule C income faces the same non-deductible interest as someone who simply forgot to file.
The Penalty and the Interest Are Blocked by Different Rules
An IRS notice usually shows two charges: the penalty itself and interest on that penalty. Neither is deductible for individuals, but the statutory basis differs.
The penalty is a fine for violating a tax rule. IRC Section 162(f) prohibits deductions for amounts paid to a government in connection with a violation of law. The underlying tax may still be deductible in the right circumstances, but the penalty portion never qualifies.2Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses
The interest is a separate charge for the time value of unpaid money. For individuals, it falls under the personal interest prohibition in Section 163(h). Same result, different section. The distinction matters when a business entity is involved, because the penalty remains non-deductible while the interest treatment can change.
Why C Corporations Can Deduct the Interest
Section 163(h) applies to “a taxpayer other than a corporation.” That phrase does the work. Because the personal interest disallowance doesn’t reach C corporations, interest on a federal income tax deficiency stays deductible under the general interest-deduction rule.1Office of the Law Revision Counsel. 26 USC 163 – Interest
A C corporation that owes interest on underpaid federal income taxes can treat that interest as a deductible expense on Form 1120, cutting its taxable income dollar for dollar. The penalty itself is still off-limits under Section 162(f), but the interest piece is an ordinary cost of doing business.2Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses
The gap is real. The same dollar of interest that is a dead cost to an individual becomes a tax-reducing expense for a C corporation.
S Corporations and Partnerships Follow the Individual Rule
S corporations and partnerships don’t pay federal income tax at the entity level. Income flows through to the owners on Schedule K-1, and any federal income tax liability lands on the individual owner’s return. Interest on a federal income tax deficiency tied to that pass-through income is personal interest once it reaches Form 1040, and Section 163(h) disallows the deduction.1Office of the Law Revision Counsel. 26 USC 163 – Interest
There is a narrow exception for taxes imposed on the entity itself rather than the owners. Some states impose entity-level franchise or income taxes on S corporations, and the federal government imposes excise taxes on certain business activities. If the entity owes interest on one of those entity-level taxes, that interest can be deductible as a business expense at the entity level. The question is always whether the tax was imposed on the entity or on the owner.
When Related Interest Is Deductible
Section 163(h) is written around income tax. A few non-income-tax situations fall outside its reach.
Estate Tax
The statute itself carves out one category of tax-related interest. Interest on unpaid estate tax during an approved extension under Section 6163 is explicitly excluded from the definition of personal interest and can be deducted.1Office of the Law Revision Counsel. 26 USC 163 – Interest More broadly, interest accrued on estate tax obligations may be deductible as an administrative expense of the estate on Form 706, because settling the estate’s tax affairs is a legitimate cost of administration.3GovInfo. 26 CFR 20.2053-6 – Deduction for Taxes
Federal Excise Tax
If a business owes interest on a federal excise tax penalty, that interest is deductible as an ordinary business expense. Excise taxes attach to specific business activities and products, not to income, so the personal interest disallowance does not apply. The interest is a cost of the business that produced the excise tax liability.
The Better Move: Ask the IRS to Abate the Penalty
Since the interest isn’t deductible, the practical play is getting the penalty itself reduced. The IRS will automatically reduce or remove related interest whenever a penalty is abated.4Internal Revenue Service. Penalty Relief A smaller penalty means less interest accrued on it, so a successful abatement saves money twice.
Two main paths to relief are available:
- First-time abatement. If you have a clean compliance history for the three prior tax years — filed on time, paid on time, no penalties — you can request a one-time waiver of failure-to-file or failure-to-pay penalties. This is administrative relief and doesn’t require proving hardship.
- Reasonable cause. If you exercised ordinary care and prudence but still couldn’t comply, because of a natural disaster, serious illness, or similar circumstances, the IRS may waive penalties on that basis.
You can request relief by calling the number on your IRS notice. Some abatements are approved on the call. If not, you can submit a written request using Form 843, Claim for Refund and Request for Abatement.4Internal Revenue Service. Penalty Relief
Don’t Deduct It Anyway
Some taxpayers try to slip penalty interest onto Schedule C as a business expense, especially when the tax came from self-employment income. It doesn’t work. If the deduction is disallowed, the IRS may add an accuracy-related penalty of 20% on the resulting underpayment, treating the claim as negligence.5Internal Revenue Service. Accuracy-Related Penalty For individuals, the accuracy-related penalty applies when the understatement exceeds the greater of 10% of the tax that should have been reported or $5,000, with a lower 5% threshold if you also claim the qualified business income deduction under Section 199A.6Office of the Law Revision Counsel. 26 U.S. Code 6662 – Imposition of Accuracy-Related Penalty on Underpayments Claiming the deduction doesn’t just fail to save money. It can produce a new penalty on top of the one you already owe.