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If you’re stuck with a tax bill that you don’t have the cash to pay, taking out a personal loan to pay taxes is a possible solution.
After all, you’re probably eager to zero out that debt, which will accrue penalties and interest until you pay in full. But is using a personal loan to pay taxes a good idea for your circumstances?
In some situations, it may be. If you’re considering this option, we’ll go over when it might make sense to take out a loan to pay taxes and when you might want to consider an alternative like a credit card or IRS installment plan.
Should I take out a loan to pay taxes?
If you apply for a personal loan to pay taxes, you’re asking to borrow money from a lender like a bank or credit union. If approved, you’ll pay down the personal loan, plus interest, over time in installments. This can be an attractive option, because — depending on your credit reports, income and a host of other factors — you may be able to get a lower interest rate than you would with a credit card.
In August 2019, the average interest rate on a 24-month personal loan from a commercial bank was 10.07%, according to the Federal Reserve. For credit cards during that same time period, the average interest rate was 15.1%.
Here are some things to think about when you’re considering a personal loan to pay your taxes.
Reasons to consider a personal loan to pay taxes
- You’ll often have a predictable monthly payment, loan term and interest rate.
- You can apply for an unsecured loan that doesn’t tie up collateral such as your home.
- It may cost you less than an IRS payment plan or credit card.
Drawbacks to using a personal loan to pay taxes
- You’ll be taking on debt.
- Your credit scores may dip once you’re in debt or if you make a late payment on the loan.
- You may pay more in interest with a personal loan than with an IRS repayment plan.
How do my options compare?
Before deciding whether to apply for a loan to pay taxes, compare how much you might pay for each option.
Here’s an example: Let’s say you filed your income tax return on time, but you can’t afford to pay the $1,000 you owe for six months. How would an IRS installment agreement compare to a credit card or a personal loan?
Let’s say the interest rate on your credit card is 15.1% and you could qualify for a personal loan with an origination fee of 3% and an interest rate of 10.07%.
|IRS installment agreement||Credit card||Personal loan|
|Processing fee (1.87%)||–||$18.70||–|
|Origination fee (3%, may be taken out of the loan amount)||–||–||$30|
|Total amount financed||$1,000||$1,018.70||$1,000|
|Interest charged over 12 months||
|Failure-to-pay penalty (0.5% monthly for 12 months)||$60||–||–|
Keep in mind that this is just an example, but as you can see from the table above, a credit card or a personal loan could be less expensive than an IRS installment agreement in this situation. Although the IRS interest rate is lower, the failure-to-pay penalty charged by the IRS can really add to your total.
You’ll also want to note that with personal loans, you may be charged origination fees that can be subtracted from the loan amount. So for this example, if you needed $1,000 and your personal loan lender charges an origination fee of 3%, you could end up with only $970 in your pocket.
What happens if I can’t pay my taxes?
If you don’t pay the taxes you owe by the time they’re due, the cost is twofold — the IRS charges penalties and interest until the balance is paid in full.
Penalties from the IRS can differ, depending on the issue.
- Failure to file — If you don’t file your income tax return by the due date, which is usually April 15, the IRS may penalize you 5% of any unpaid tax every month or part of a month the return is late, for up to five months. If your return is more than 60 days late, you’ll owe either the entire amount or $215, whichever is less.
- Failure to pay — Income tax is due as you earn it, so if you don’t pay enough through quarterly estimated tax payments, via withholding or at tax time, then the IRS can charge an underpayment penalty. It’s 0.5% for each month or partial month you don’t pay the taxes due, up to a maximum of 25% of the amount of tax that remains unpaid. The penalty rises to 1% if you fail to pay within 10 days after the IRS issues a notice of intent to levy property.
- Dishonored check — If your payment doesn’t go through, the IRS can penalize you 2% of the tax due for payments of $1,250 or more. For payments under $1,250, the penalty is the amount of the payment or $25, whichever is less.
The IRS also begins charging interest, compounding daily, on the day your tax is due. This is true even if you get a filing extension — any tax you owe is due on the original filing due date, no matter what your extended filing date is. Interest rates are set quarterly. For the fourth quarter of 2019, the rate is 5% for underpayments (4% for corporations).
Alternatives to using a personal loan to pay taxes
If you’re faced with a tax bill you can’t pay right away, you may have other options, including using a credit card or taking on a payment plan with the IRS.
IRS payment options
The IRS has some options to help people pay the taxes they owe.
- Full payment within 120 days — Can you afford to pay the amount in full within a few months? If so, you may qualify for additional time to pay your tax bill. The IRS doesn’t charge a fee for this arrangement. But interest and any penalties continue to accrue until you pay your balance in full. It’s a good idea to pay as much as you can, when you can, rather than waiting until the end of the 120-day period to make the full payment.
- Installment agreement — If you need a little more time to pay, you can apply for an installment agreement. When you apply for an installment agreement, you tell the IRS how much you can afford to pay each month and the IRS can either approve or deny your request. Unlike the 120-day plan, there’s a setup fee (up to $225) for this option. Again, interest and any penalties will continue to add up until you pay your balance in full. But you may be able to have the setup fee waived or reimbursed if you qualify as a low-income taxpayer.
You can pay your taxes with a credit card. You’ll pay a processing fee to a third-party payment processing company, which can vary depending on the processor you choose and your card issuer. Currently, the processing fee for credit card payments ranges from 1.87% to 1.99% of the payment amount (minimum of $2.50 to $2.69). The good news: That fee may be tax deductible.
Of course, you’ll also want to factor in your credit card’s current interest rate, which can vary depending on the credit card you use. As of August 2019, the average credit card interest rate at a commercial bank was 15.1%, according to data from the Federal Reserve.
If you qualify for a credit card with a 0% intro APR, then you’ll have time to pay off the debt without paying interest. Just be sure to pay off any unpaid balance before the intro period is up, otherwise you’ll start accruing interest. We recommend doing the math to determine whether using a credit card could be more cost effective for your situation.How to lower your credit card interest rate
Once you’ve figured out how to pay your tax bill, consider what you can do to avoid this situation next tax season. For example, you could ask your employer to adjust your W-4 withholding. If you’re self-employed, you could adjust your quarterly estimated taxes or work with a tax professional to figure out how much tax to set aside.
You may also decide to create a separate savings account for taxes and deposit money into it throughout the year.
But try to avoid using short-term borrowing options, such as payday loans and title loans. These usually come with high fees and may require collateral.