Should you take out a personal loan to pay taxes?

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In a Nutshell

If you owe money to the IRS and can’t afford to pay, a short-term personal loan might be a solution. But it’s important to understand the costs involved and how personal loans work. We’ll compare paying off your federal tax bill, including any income taxes, with a personal loan to other solutions, like using a credit card or an IRS installment agreement.

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Nothing good can come from failing to pay your tax bill.

If you owe the IRS back taxes, you could face both penalties and interest that build on the unpaid balance until you pay in full. But if you’re stuck with a tax bill that you don’t have the cash to pay, what are your options?

One solution may be to pay your taxes with a personal loan. The question is whether using a personal loan to pay taxes is a good idea. In some situations, it might be. But you should understand all the costs involved first, and consider other alternatives, too.


What happens when 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 can charge penalties and interest until the balance is paid in full.

Penalties

Penalties can differ depending on the issue. Some common penalties occur when you fail to file, don’t pay the right amount of estimated tax or file but don’t pay the tax that you report.

Let’s say you file your tax return on time and it correctly shows how much you owe. If you fail to pay the entire amount due by the due date, the penalty is 0.5% of any unpaid tax amount. That penalty is charged every month on the remaining unpaid tax until it’s fully paid (up to 25% of the amount owed).

In this scenario, if your tax bill is $1,000, the additional penalty would go up $5 every month, to a maximum of $250.

You can learn more about IRS penalties here.

Interest

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 third quarter of 2018, the rate is 5% for underpayments.

So on that return you filed, let’s say your tax bill was $1,000. If you don’t make any payments toward that balance by tax day, but then you decide to pay in full on October 15 of the same tax year, here’s how your charges could break down.

  • $30 in failure-to-pay penalties (six months at a rate of $5 per month)
  • $27.33 in interest (six months at a rate of 5% compounded daily)

You’d end up owing the IRS around $1,057.33 in total.

IRS payment options

If you owe taxes, including income taxes, to the IRS that you can’t afford to pay, you’re not alone. According to the IRS, at the end of the 2017 fiscal year, it collected nearly $40 billion in unpaid assessments on returns filed with additional tax due.

The IRS has some options to help taxpayers pay the tax 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. So 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 $107) 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 if you qualify as a low-income taxpayer. 

Other payment options to consider

By now you’re probably getting the idea — the big drawback of paying the IRS over time is that interest and penalties can add up. In fact, those extra charges can become such a burden that the IRS suggests you consider using a loan or credit card to pay your taxes on time — the idea being that bank or credit card interest could be less costly.

Many people wonder whether using a credit card or personal loan is a better option than paying their tax late and racking up IRS interest and penalties. Let’s compare these options.

Credit card

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 May 2018, the average credit card interest rate at a commercial bank was 14.14%, according to data from the Federal Reserve. We recommend doing the math to determine whether using a credit card could be more cost effective.

How to lower your credit card interest rate

Personal loan

Using a personal loan to pay your taxes can be an attractive option, because — depending on your credit, income and a host of other factors — you may be able to get a lower interest rate than you would with a credit card.

Until relatively recently, personal loans were typically available only through banks and credit unions, but several online lenders have entered the market, making personal loans available from a wider group of lenders.

Find a personal loan that works for you

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According to the Federal Reserve, in May of 2018 the average interest rate on a 24-month personal loan from a commercial bank was 10.31%. In addition, some lending platforms charge an origination fee typically ranging from 1% to 6% of the loan amount.

Going back to our scenario above when you filed your return on time but can’t afford to pay the $1,000 you owe for six months. How might an IRS installment agreement compare to a credit card or a personal loan?

For the example, let’s say the interest rate on your credit card is 14.14%, and that you could qualify for a personal loan with an origination fee of 3% and an interest rate of 10.31%.

IRS installment agreement Credit card Personal loan
Tax owed $1,000 $1,000 $1,000
Setup fee $31

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 rate 5% 14.14% 10.31%
Interest charged through Oct. 15

 

$27.33

 

$42

 

$31

Failure-to-pay penalty (.5%/monthly) through Oct. 15 $30

Total paid $1,088.33 $1,060.70 $1,031.00

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 a less expensive option than an IRS installment agreement in this situation. Also take note that with some personal loans, you may be charged an origination fee that can be subtracted from the loan amount. So for this example, if you needed $1,000 and your personal loan lender charges a origination fee of 3%, you could end up with only $970 in your pocket.

Although the IRS interest rate is lower, the failure-to-pay penalty charged by the IRS can really add up. Remember that credit cards and personal loans can have drawbacks as well, so make sure to do your research before deciding which payment method is right for you.


Bottom line

Not having enough money to pay your IRS bill, including any income taxes, can be a common problem. But a good solution to that problem will be unique based on your particular financial situation.

It can depend on the amount you owe, how soon you can come up with the money to pay your tax bill, and the interest rate you can get on a credit card or personal loan. The comparison above would change significantly if you could open a credit card with a promotional offer (like an intro 0% APR on purchases) to take advantage of interest-free payments.

Regardless of which option you choose, try to plan to have enough money set aside so you don’t fall short next year.

Are you among the millions who are projected to owe the IRS next year due to under-withholding?