IRS Refund Interest Will No Longer Be Taxed for Individuals and Small Businesses Under New Bill

The “Cutting Paperwork for Taxpayers Act” focuses on one very specific, but potentially annoying, detail of the tax code: how the IRS treats interest it pays you when it issues a tax refund. If you’ve ever overpaid your taxes and waited a long time for the refund, the IRS eventually pays interest on that money. Currently, that interest counts as taxable income, meaning you have to pay tax on the money the government paid you for holding your money too long.

This bill changes that for individual taxpayers and eligible small businesses. Under Section 2, the interest the IRS pays on an overpayment (calculated under Section 6611) will no longer be counted as part of your gross income. Translation: You get to keep the full amount of that interest payment, tax-free. This change applies to all tax years starting after the law is officially enacted.

The Check is Finally in the Mail (and it’s all yours)

Think of it this way: Say you mistakenly overpaid your 2023 taxes by $5,000, and it took the IRS a year to process your refund. They might pay you $5,000 plus $200 in interest. Right now, you’d have to report that $200 as income and pay income tax on it. If this bill passes, that $200 is completely exempt from federal income tax. For the average individual, this isn't a massive windfall, but it’s real money you get to keep, and it simplifies things significantly.

Less Headaches for Small Business Owners

The provision extends this same tax break to “eligible small businesses,” which are defined using an existing tax code section (44(b)(1)). This typically covers businesses with average gross receipts below a certain threshold. For a small business owner—maybe someone running a local construction company or a digital marketing firm—getting a big tax overpayment refund, especially one that takes a while to process, can involve a significant interest payment. Exempting that interest from taxation means more cash stays in the business, which can be critical for managing cash flow or making payroll.

Cutting the Paperwork, Literally

Beyond the financial benefit, this bill addresses a minor, but irritating, administrative burden. Every year, millions of taxpayers receive a 1099-INT form from the IRS reporting that interest income. You then have to manually enter that number into your tax return and pay tax on it. By making the interest non-taxable, the government is essentially cutting out a step in the tax preparation process for those affected. While your tax software might handle it, eliminating a line item—and the associated tax liability—is a small victory for simplification. It’s a clean, direct change that benefits taxpayers by letting them keep the full interest paid on their own money.