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July 07, 2008

A reader asked taxblogger Robert D. Flach whether the IRS interest rate on overpayments is high enough to make it worthwhile to overpay taxes on an original return and then file a refund at a convenient later date.

It depends a lot on whether you have time on your hands and the ability to do your own taxes.

The IRS is currently paying 5% on overpayments. The highest savings account rates are running 3% to 4%. If you pay $10,000 in extra taxes, you might earn, say, 2% more than you you would from the IRS than you would at your friendly banker. If you leave the money with the IRS for six months, you would earn an extra $100.

The catch? You only earn interest if you file an amended return. You normally don't get paid interest when you get a refund on a timely-filed extended return. You would have to file a full-blown return with an income overstatement high enough to support your $10,000 payment, and then you would have to file an amended return to get your $10,000 back.

Assuming all goes well, it's hard to believe you can do all of the work involved in less than two hours, even if you are good at return prep. That's $50 per hour for your time. If the amended returns generate IRS notices, you have more time invested. It's hard to see how this is a good use of your time, unless maybe you are in prison and you have all the free time in the world.

And the whole prison thing isn't entirely out of the question. Taxpayers have gotten in trouble for filing false returns overstating their income - typically to perpetrate creditor fraud. If you overdo it, the IRS might not be amused.

All in all, it seems like a better idea to go on the internet to shop savings rates than to game the IRS overpayment rate.

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