My interest on my tax debt is adding up. Should I pay it off with a loan?
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Dear Reliable Trainer,
I owe 16,000 IRS, interest added daily. Should I take a loan with interest? – Mom
Hello Mum and thank you for your question. Many Americans feel stressed when the tax season arrives. But if you have a tax debt, this anxiety can last all year round.
Your question highlights the biggest problem with tax debt – interest. You may also face penalties when you owe taxes, but interest is what keeps your debt growing. And the interest will keep increasing as long as you do pay off the debt. Tax debt can be so onerous that the IRS actually recommends taxpayers either liquidate their assets to pay off the debt or consider getting a loan, as both options may be cheaper in the long run than paying penalties and interest to the IRS.
Before you take out a personal loan for whatever reason, it’s a good idea to compare the rates of multiple lenders. Credibility makes it easy view your pre-qualified personal loan rates.
How tax debt works
Whether it’s a payroll deduction or estimated tax payments, the IRS expects you to pay at least 90% of the tax you owe in the months leading up to the tax return and due date, and any remaining balance up to the due date.
If you don’t reach these 90%, you may face an underpayment penalty in addition to your remaining balance, although there are some exceptions. And if you make the mistake of not submitting your tax return on time, in addition to not paying your full tax liability, you may also face a failure to submit a fine.
How tax debt can grow
Any tax balance that you do not pay in full by tax date has an interest rate of 3% which, as you noted in your question, is accrued daily. Interest is on the total unpaid balance, including the amount of tax due, any penalties and any unpaid interest.
While 3% may not seem like much, putting together blends every day can make your debt go up. For example, a tax bill (principal, penalties and interest) of $ 5,000 may increase to $ 5,152 at the end of the first 12 months if not paid.
Tax debt repayment options
When it comes to paying off your tax debt, you have several options:
Payment in cash
If you have $ 16,000 in savings to cover that balance, and immersing yourself in these funds won’t cause you a financial hassle, paying off your entire balance right away is your best bet. The downside to this option is that you will save a lot of money.
IRS Payment Plan
IRS payment plans are an option if you want to spread your tax debt into manageable payments. The IRS allows taxpayers to make short-term and long-term payment plans, and requesting one is fairly easy. You can call 800-829-1040 or request an online payment plan.
But IRS payment plans have drawbacks, including interest and fees for setting up or making changes to the plan. If you go on a long-term plan it can take a long time to pay off all your debt and interest will continue until you pay off the balance.
When using the loan to pay your tax bill it is literally swapping one type of debt for another, and it may make sense in some situations.
If you have a credit card with a large balance available, paying your tax bill may be your quickest option. But this is rarely the best as interest rates on credit cards can be high. According to data from the Federal Reserve, at the end of 2021, the average rate on credit cards with interest was 17.13%.
Depending on your creditworthiness, your rate may be significantly higher than the average. Also, since credit cards are revolving loans, your interest rate and costs may increase as you go pay off the debtwith no final end date visible.
Whereas interest on personal loans They tend to be lower than credit card rates, so if you must use a loan to pay off your tax debt, a personal loan may be a less expensive option. According to the Federal Reserve, at the end of 2021, the average rate of a 24-month personal loan was 9.39%. Since personal loans are installment loans, you will have a specific maturity date and you will know exactly how much interest you will pay over the life of the loan before signing on the dashed line.
But personal loans can have downsides. Some lenders charge you to start or apply for loan processing and prepayment penalties if you pay off the loan early, so it’s important to fully understand the terms of any loan you are considering.
Is a personal loan the best option to pay off your tax debt?
Mom, if your credit is good or perfect and you meet the income requirements, you may qualify for a personal loan of $ 16,000 with favorable interest rates and conditions. A personal loan can help you pay off your tax debt and avoid soaring interest costs that could come from unpaid tax debt, credit cards, or the IRS installment plan.
Finally, don’t underestimate the mental health benefits that you can get from paying off your tax debt. Some forms of debt can be more stressful than others, and tax debt – which can lead to wages seized, liens and foreclosed assets – is definitely a stressful type of debt. You can rest easy knowing that you owe the personal lender, not Uncle Sam, and that your interest will not continue to increase as you pay off your debt.
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About the author: Dan Roccato is clinical professor of finance at the University of San Diego School of Business, Personal finance expert Credible Money Coach, author of publications and entrepreneur. He has held managerial roles in Merrill Lynch and Morgan Stanley. He is a recognized expert in personal finance, global securities services and corporate stock options. You can find it on LinkedIn.