Using a Loan to Pay Your Taxes : Inside UK

As the tax deadline draws near, one of your biggest worries may be owing money to Uncle Sam. The IRS reported that, as of about a month after last year’s filing deadline, 30.5 million tax returns ended up with a balance due for their 2021 taxes.

“If you owe money in taxes and find yourself short on cash, don’t panic,” says Billy Lanter, fiduciary investment advisor at Unified Trust Co. of Lexington, Kentucky. “There are several options available to consider, but some are certainly better than others.”

Using a loan to pay taxes is one possibility. Financing tax payments can help you avoid IRS penalties and interest, though it has pros and cons.

Although you can use an IRS installment agreement to finance your tax bill, you could save money if you can qualify for a loan with lower interest charges and fees. You could pay your taxes with these types of loans:

If you’re wondering whether to use a loan to pay your taxes or how to get one, this guide can help.

Yes, you can use a personal loan to pay your taxes.

“You can use a personal loan for almost any legitimate purpose, including to pay your taxes,” says Josh Zimmelman, owner and founder of Westwood Tax & Consulting in New York City.

A personal loan could allow you to borrow anywhere from $1,000 to $100,000, depending on loan limits. If a lender has a high limit, keep in mind that your ceiling will be based largely on your credit score, income and debt.

Collateral can make approval easier for a borrower because the lender can seize your collateral if you can’t repay your loan. This lowers risk for the lender but raises risk for the borrower.

A home equity loan may be another option to consider when you have to pay Uncle Sam, and sometimes it can be a better choice than a personal loan.

Taxpayers with good credit and home equity may qualify for an interest rate that is lower than interest rates and penalties on IRS payment plans, Lanter says.

As with personal loans, you can’t deduct the interest you pay on your taxes.

If you owe business taxes, especially if you have a big tax bill, you may prefer a business loan rather than a personal loan because borrowing limits are higher. Plus, you can deduct interest you pay on business loans.

Deductions may cut your tax bill by reducing your taxable income. You cannot deduct interest you pay on personal loans.

Watch out for personal guarantees on business loans, though. A personal guarantee typically requires a business owner to repay the loan if the business cannot.

Taking out a loan to cover a tax bill has some upsides, starting with avoiding interest and penalties.

If you file your taxes and owe the IRS money but don’t pay in full, Uncle Sam can charge you a failure-to-pay penalty, plus interest on the outstanding amount. The failure-to-pay penalty is 0.5% of your unpaid taxes, charged each month your bill is unpaid.

Using a loan to pay taxes could help you prevent those penalties because you would owe the lender, not the IRS. The key is making sure you choose a personal loan with lower fees than what the IRS would charge.

A loan could also provide clear terms and a less risky way to pay tax debt than with an IRS payment plan. “Taking a loan to pay taxes may not sound all that appealing, but it’s preferable to having the IRS garnish your wages or file a tax lien against your property,” Lanter says.

The IRS can take both of these measures if a federal tax bill goes unpaid. In fact, the IRS can garnish your wages without first getting a judgment and may be able to take more than a regular creditor can.

Wage garnishment won’t happen right after missing the tax deadline, but don’t take your chances. Moving your tax debt to a private loan reduces the risk of landing in a tricky financial situation.

Before you pursue a loan, consider the choice from every angle.

“While getting a loan to pay a tax bill is an option, there are definitely downsides that come along with this,” Lanter says. “You’ve taken care of the IRS issue but potentially created additional problems.”

Will the loan stretch your budget? If a new loan payment eats into what is already a strained budget, that could increase your likelihood of default, Lanter says.

This may be particularly true, he adds, if you’ve had to adjust your tax withholding to avoid a big bill at tax time next year. “Paying off your new loan may require some lifestyle changes to ensure you can meet your obligations,” Lanter says.

You don’t want to risk defaulting on a loan, which can stay on your credit report for up to seven years from the date your account first became delinquent.

Using a personal loan to pay taxes could be costly if you don’t qualify for the lowest interest rates. And as with a home equity loan, your home is on the line as collateral – if you default, the lender could foreclose on it.

Also, applying for a loan can result in a slight ding to your credit score because inquiries for new credit show up on your credit report. The good news is that if you’re rate shopping for home equity or personal loans, multiple inquiries may be treated as a single inquiry for credit-scoring purposes.

Consider whether setting up an IRS payment plan is an option before getting a loan to pay taxes.

“To set up an installment agreement, the IRS will look at what you owe and come up with a minimum payment,” Zimmelman says.

A setup fee of up to $225 applies to long-term installment plans, and penalties and interest accrue on the balance until your tax bill is paid in full. Interest accumulates on unpaid taxes from the due date of your return – compounded daily at the federal short-term interest rate, plus 3%.

Getting a loan to pay taxes means researching your needs and various lenders, then comparing the minimum requirements for approval with your credit history and financial health.

When weighing options for financing tax payments, consider:

If you don’t want to use a loan to pay your taxes, you have a few other options. You could:

A credit card with a 0% introductory APR offer might provide interest savings, but there’s a hitch. “You’ll likely get stuck with an additional processing fee if you pay by credit card,” Zimmelman says.

The processing fee to pay your tax bill with a credit card ranges from 1.85% to 1.98% of the payment amount. On a $5,000 tax bill, that adds up to between $92.50 and $99.

At a minimum, the IRS charges a $2.20 fee to pay with your card. A loan could help you avoid this added cost.

Even if you’re earning cash back rewards, miles or points on your credit card transaction, the processing fee could easily wipe out the value you’re getting. And the introductory rate doesn’t last forever: You’ll pay interest on any balance that remains after the introductory period.

If you can’t or don’t want to use a credit card, you might look at taking a 401(k) loan or distribution from a retirement plan. The benefit is that you’re paying back the money to yourself, but there are consequences.

“Pulling funds out of a retirement plan can be incredibly costly and should be viewed as an option of last resort,” Lanter says.

Depending on the account, you could face a 10% early withdrawal penalty and pay income tax on the withdrawal.

You could avoid those penalties with a 401(k) loan, but only if you repay the loan on time. If you left your job, the loan would be payable in full, and if you didn’t pay, it would become a taxable distribution.

Not to mention, taking money from your retirement account means it can’t grow.

“When taking into account the taxes due on the distribution, the 10% early withdrawal penalty if you’re under age 59 1/2, and the impact of losing compound interest years, this is likely the most expensive option available,” Lanter says.

Borrowing money from friends and family members could be less costly. “Most likely, they won’t charge you interest, or at least they’ll charge you a more reasonable rate than you’d get offered at a bank or through a credit card,” Zimmelman says.

But there is a downside. “Mixing finances with friendship can put a strain on the relationship, especially if you aren’t able to pay them back in a timely manner,” he says.