Personal Loan To Pay Taxes: Smart Strategy or Risky Choice?
Owe more taxes than you were expecting? If you’re struggling to pay your tax bill, a personal loan can be a quick solution.
Although it’s perfectly legal to pay taxes with a personal loan, there may be a cheaper alternative. The IRS offers repayment plans, but there are other options to consider, too. Don’t worry, we’ll help you figure it out.
- You can pay taxes with a personal loan.
- Personal loans aren’t the only way to borrow money for taxes. You could use a credit card, work something out with the IRS or borrow from your retirement.
- Do not ignore filing taxes, and make your best effort to pay on time. Interest racks up fast on unpaid taxes, and you’ll be subject to penalties that also accumulate interest.
Should you use a personal loan to pay taxes?
You can use a personal loan to pay taxes. Personal loans come as a lump sum of money that you can use for almost anything. You’ll pay back what you owe in equal installments, plus interest.
But is paying taxes with a personal loan a good idea? It depends on your personal loan rate, your credit score and how quickly you can pay off what you owe.
Generally, paying taxes with a personal loan might be best if you have excellent credit and need a few years to pay your taxes. But a personal loan is just one option.
First, use a personal loan calculator to see how much interest you’d pay on a loan. This will help you decide if a personal loan is worth pursuing. Take that rate and compare it to the alternatives below.
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Alternatives to pay your tax bill
IRS payment plan
Why we like it: IRS payment plans currently carry an interest rate of 7%, which is lower than most personal loans. Also, most people who owe taxes qualify for a plan. Loans and credit cards can be hard to get if you have bad credit.
Why we don’t like it: The IRS uses compounding interest. And even on payment plans, it still charges a failure to pay fee (although discounted).
The IRS offers several forms of tax debt relief, including payment plans. One of the most popular of those is the Simple Payment Plan.
More than 90% of people who owe qualify for the Simple Payment Plan. As long as you owe less than $50,000 in back taxes, including interest and fees, you could have up to 10 years to pay back your debt.
Interest on IRS repayment plans can be hard to handle if you’re not careful. Interest compounds, which means you’ll pay interest on your interest. Keep in mind that failure to pay fees also accrue interest. Personal loans usually use simple interest, so you only pay interest on what you borrowed.
You can find more details on IRS payment plans on its website.
Settle with the IRS (offer in compromise)
Why we like it: You could end up paying less than what you owe. Also, once you are approved, interest stops accruing on what you owe.
Why we don’t like it: Offers in compromise are hard to qualify for.
An offer in compromise is getting the IRS to agree to accept less than what you owe.
To qualify, the IRS has to determine that paying your back taxes in full will cause you financial hardship. How much you’ll owe (if you’re accepted) depends on how much you make, your current expenses and more.
Offers in compromise have strict requirements. You can’t have an open bankruptcy or be behind in filing or payments. You can see if you’re eligible with this IRS prequalification tool.
0% APR credit card
Why we like it: You will avoid paying interest as long as your balance is clear by the end of the promotional period. Promo periods usually last from six to 21 months.
Why we don’t like it: You typically need at least good credit to qualify. You also need to pay off your taxes during the promotional period to pay no interest.
If you pay your taxes with a 0% APR credit card, you won’t pay any interest as long as you pay your balance before your promo period is up. Pro tip: Try to find a 0% annual percentage rate (APR) card with a sign-on bonus for extra money in your pocket.
Interest kicks in after your promotional period, and it’s typically in the double digits. Having a payoff plan is essential. Also, 0% APR cards generally require a 670+ FICO Score.
401(k) loan
Why we like it: 401(k) loans don’t require a credit check or affect your credit. You’ll also pay interest back to yourself.
Why we don’t like it: You will miss out on some investment growth. Your loan could also be due all at once if you leave your job. Unpaid 401(k) loans are taxed as income, and you could incur a possible penalty.
You could take out a 401(k) loan, as long as your specific plan allows it. A 401(k) loan can be a great tool because all of the interest you pay goes back into your 401(k).
There are some important downsides to consider. One, the money you take out of your 401(k) will lose out on potential growth.
Also, if you leave your job, your remaining balance could be due immediately. If you can’t pay back your loan, it is considered a distribution and will be taxed as income. If you’re under 59 1/2 years old, you’ll also pay a 10% penalty.
Pros and cons of using a personal loan to pay taxes
Pros
- Applying for a personal loan is fast. With some quick loans, you can get money the same day that you apply. This can help you pay off the IRS before they can charge a failure to pay penalty, seize property or garnish your wages.
- Personal loans don’t come with a 0% APR period, but you will have more time to pay off your balance. You’ll usually have between 12 and 84 months to pay off a personal loan. Promotional periods offered by credit cards are typically six to 21 months.
- Bad credit personal loans are easier to qualify for than 0% APR cards (but can come with rates of 35.99%). Interest also doesn’t compound like it does on an IRS payment plan.
- You might have a hard time paying a personal loan if you lose your job, but your entire balance won’t be due all at once like it would be with some 401(k) loans.
Cons
- Unless you have excellent credit or can pay off your loan early, you may pay less interest on an IRS payment plan than you would with a personal loan.
- Unlike with a 401(k) loan, late personal loan payments impact your credit score. A personal loan also affects your debt-to-income ratio. 401(k) loans don’t.
- You will be responsible for the entire amount you owe in taxes, but you may be able to settle with the IRS for a lesser amount than you owe. Depending on how much you owe after the settlement, you might be able to afford to pay your taxes without borrowing.
How to find a personal loan with LendingTree
- Tell us how much you need. Fill out one quick form to access our exclusive network of lenders. Let us do the shopping for you, with no impact to your credit.
- Compare offers for free. Skip the runaround and compare offers from up to five lenders at one time.
- Get matched and get paid. Once you find the personal loan that works for you, we’ll help you take the next steps to apply.
Tax scenarios where borrowing money might help
Borrowing money for taxes can make sense, whether you’re a W-2 worker or a 1099 contractor.
- Self-employed individuals and freelancers: Your income likely fluctuates, and you may also have a high tax burden, thanks to self-employment tax. If you have a big tax bill, you could borrow money instead of dipping into your reserves.
- W-2 employees: You might need to borrow money for taxes if you get slapped with a higher-than-expected tax bill for choosing the wrong withholdings.
- Side hustlers: Nearly 40% of Americans have a side hustle, according to a recent LendingTree survey. But did you know that you have to pay taxes on those earnings if you make more than $400 in a year? If you’re facing unexpected taxes and penalties, a personal loan could help.
What happens if you can’t pay your taxes?
The IRS does not report late or missed tax payments to the credit bureaus. But if you’re late enough, the IRS might place a federal tax lien against you. A tax lien gives the IRS a legal right to your property, like your house.
Tax liens are public record. Creditors and lenders can see public records so even if the IRS doesn’t report to the bureaus, a tax lien will probably make it harder to do things like get a loan or rent an apartment.
If you don’t pay your taxes, you could also drive up the cost of your tax bill with the following penalties. To make matters worse, the IRS can charge you interest on any unpaid penalties, along with the amount you owe.
If you don’t file on time
If you owe money and don’t file your tax return on time, the IRS will charge you a failure to file penalty. The penalty is 0.5% of your unpaid taxes for each month or partial month the filing is late. This penalty is capped at 25% of your balance.
Avoid this penalty by applying for a filing deadline extension. This penalty doesn’t apply if you don’t owe taxes.
If you don’t pay on time
If you owe taxes and don’t pay them by the due date, the IRS will charge a failure to pay penalty. For each month or partial month the tax is unpaid, the IRS will charge you 0.5% of the unpaid amount. The penalty is capped at 25% of your unpaid balance.
If you’re on an IRS payment plan, you’ll still receive this penalty, although it’s discounted by 0.25% per month or partial month. If the IRS sends you an intent to levy notice and you still don’t pay, your penalty can increase.
In addition to this penalty, the IRS will also charge you interest on the taxes you owe. The interest rate is set each quarter. As of this writing, the IRS interest rate is 7% for individuals, compounded daily.
If your payment bounces
Another penalty applies if your tax payment doesn’t go through. For bounced tax payments of $1,250 or more, the IRS will charge a 2% penalty. For bounced tax payments below that, the IRS will charge the amount of the check or $25, whichever is less.
Frequently asked questions
You could get a loan to pay off the IRS, but figure out how much overall interest you’ll pay on it versus an IRS payment plan.
Most personal loans have simple interest, and IRS payment plans charge compounding interest. Compounding interest is an expensive way to borrow, because you pay interest on your interest instead of just on your principal.
Prequalify for a few personal loans and compare those offers with the interest you’d pay on an IRS repayment plan. Alternatively, if you have excellent credit and can pay off your taxes in a shorter amount of time, a 0% APR card may be the best option.
You could use a personal loan to pay taxes, or see if you qualify for an IRS repayment plan. 0% APR cards are a fantastic option if you qualify and can pay off your taxes before your promo period ends. If all else fails, you can see if a loved one would be willing to give you a family loan.
In some cases, the IRS offers penalty relief.
You might be able to get a failure to file or failure to pay penalty reduced or waived if you can prove to the IRS that you tried to pay your taxes but just couldn’t. One way to do this is by providing reasonable cause. Some examples of reasonable cause (for the IRS) include a death in your immediate family or a natural disaster.
If you receive a penalty, you should get a letter from the IRS with instructions on how to apply for penalty relief.
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