This act exempts interest paid by the IRS to taxpayers on tax overpayments resulting from audits, litigation, or civil tax collection actions from gross income.
Marsha Blackburn
Senator
TN
The No Tax on Wrongful Delay Act of 2026 exempts interest paid by the IRS to taxpayers on tax overpayments from gross income. This exemption applies specifically to interest resulting from IRS audits, taxpayer lawsuits for refunds, or civil actions initiated by the U.S. government to collect taxes. This change aims to prevent taxpayers from being taxed on compensation received for delays caused by the government.
Tax-Free Interest on IRS Refunds: No Tax on Wrongful Delay Act Set for 2026
The No Tax on Wrongful Delay Act of 2026 changes a frustrating quirk in the tax code: the fact that the government currently taxes you on the interest it pays you when it holds onto your money for too long. Starting in the 2026 tax year, any interest the IRS pays out on tax overpayments—specifically those resulting from audits or legal disputes—will be officially exempt from your gross income. Under the new Section 139M of the Internal Revenue Code, if you win a refund after a long battle, the extra interest cash you receive stays entirely in your pocket instead of being treated as taxable income.
Keeping the Change
Currently, if the IRS flags your return for an audit under Section 7602 and eventually realizes they actually owe you a refund, they have to pay you interest for the time they kept your cash. The catch? You usually have to report that interest as income and pay taxes on it the following year. This bill stops that cycle. For example, if a small business owner spends two years in an audit only to find out they overpaid by $5,000, the interest the IRS adds to that check will no longer be sliced down by the taxman. It treats that interest more like a reimbursement for lost time rather than a fresh paycheck.
Legal Wins and Long Waits
The bill specifically targets three scenarios where interest is paid under Section 6611: following an IRS examination, after a taxpayer wins a lawsuit for a refund, or after the government loses a civil action to collect taxes. This means if you have to hire a lawyer to get your rightful tax credit back, the interest you earn on that delayed money won't be further eroded by taxes. It’s a straightforward move that removes a layer of double-dipping, ensuring that when the government is at fault for a delay, the taxpayer isn't penalized for the 'profit' of the interest paid to make it right.