Can You Take Out a Personal Loan to Pay Taxes?
With taxes due and cash limited, you may wonder if you can use a personal loan to pay taxes.
Contributing Writer at Tally
April 14, 2022
When tax time rolls around, many people are expecting a tax refund. In some cases, though, when you file your tax return, you owe the Internal Revenue Service (IRS) money for underpaid taxes. If this was unexpected, you may not have the cash available to pay the amount you owe.
This may leave you wondering if you can take out a personal loan to pay taxes. We cover whether you can use a personal loan to pay taxes and more below.
So, can you take out a personal loan to pay taxes?
As long as your taxes get paid on time, the IRS has little interest in what funds you use to pay them — as long as you obtained the funds legally. So, yes, you can take out a personal loan to pay off your income tax in a pinch.
Also, while some types of loans, like mortgages or student loans, are meant to be used for specific purposes, a personal loan is much more flexible; you can use it for a wide array of things.
Should you take out a personal loan to pay taxes?
Whether or not you should take out a personal loan to pay your income taxes depends on some variables. Some keys in this, though, are the loan terms and how much the personal loan will cost in interest charges, origination fees and other fees. Then compare these costs to the fees and interest the IRS charges for an installment plan.
IRS payment plan options
If you opt for an installment agreement through the IRS, you’ll initially have two options. First is a short-term repayment plan with no setup cost, but you must pay off your tax bill within 180 days.
The second option is a long-term repayment plan, which is where you agree to monthly payments for an extended period. If you have your payments directly debited, the set-up fee is just $31, but paying by check or other means requires a $130 set-up fee. You’ll accrue interest and other fees in this payment plan until the tax debt is paid off.
IRS payment plan interest rate
The IRS will charge you a variable interest rate equal to the federal short-term rate plus three percentage points on the short- and long-term plan. So, if the federal funds rate is 1.25%, you’d pay 4.25% interest. This interest compounds daily, so it can add up quickly.
IRS payment plan penalties
When you don’t pay your taxes on time, the IRS will hit you with a penalty of 0.5% of the unpaid balance each month to a maximum of 25%. So, if you left your taxes unpaid for 10 months, you would’ve paid penalties totaling 5% of your unpaid balance.
However, if you enter into a payment plan with the IRS, it’ll cut the penalty to just 0.25% per month. The cap, however, will remain the same at 25%.
Payment plan versus personal loan
To determine if a personal loan makes financial sense compared to the IRS payment plan, you must compare the loan interest rate to the payment plan interest and fees. So, say the IRS payment plan is currently at 5% interest, and every 12 months, you’ll accrue 3% (0.25% x 12 months = 3%) in failure-to-pay penalties, giving you an effective interest rate of 8%.
If you have an excellent credit history and can secure a personal loan with a rate of 8% or lower, the loan makes more sense. But keep in mind the IRS interest rate is variable; it could go up. You can always take out the personal loan to pay off the installment plan and lock in a lower interest rate if it rises.
When doing your calculations, don’t forget to add in any fees associated with the loan, like administration and origination fees. These fees can add significantly to the total loan cost.
You also want to consider your credit report and score. Taking out a personal loan will add a new hard inquiry to your credit report and a new loan, both of which can negatively impact your credit score. Also, lenders will use this loan when calculating your debt-to-income ratio, which could impact future financing opportunities. An IRS installment plan, on the other hand, won’t impact your credit score and doesn't show up on your credit report.
Of course, if you can afford to pay off your tax debt within the 180 days allowed on the short-term repayment plan, it’s your best bet. It’ll accrue the lowest fees and has no up-front cost.
What are other ways to pay off your tax debt?
You have more payment options than just a personal loan or an IRS repayment plan for settling your unpaid taxes. Here are a few other ways to square up with the IRS.
Generally, a credit card won’t be the best way to handle your unpaid tax debt, as credit card interest rates will likely be far higher than the IRS repayment plan. However, if you can secure a credit card with a promotional APR, like 0% APR for 18 months, you can use this for tax payment and pay no interest or fees during the promotional period.
Keep in mind the IRS uses payment systems that charge about a 2% processing fee for credit card payments.
Home equity line of credit (HELOC)
A HELOC leverages the equity you have in your home — the home's value minus the total amount you owe on any mortgages tied to the home — to get a low-interest line of credit. Borrowers generally use a HELOC for debt consolidation, home improvement or home repairs, but you can also use this line of credit to pay off tax debt.
While this is a flexible way to pay off your taxes with a low interest rate, this isn’t an unsecured loan like a personal loan. A HELOC is tied to your home, and the lender can foreclose on your home if you don’t pay back the money you borrowed.
Because this is a line of credit you can draw from, you only pay interest on the amount you use.
Home equity loan (HEL)
An HEL is similar to a HELOC, but it’s a fixed loan amount. Like a HELOC, this is a secured loan tied to your home, and you risk losing your home to the loan issuer if you default.
Offer in compromise
You may qualify for an offer in compromise (OIC) depending on your financial situation. When you file for an OIC, the IRS reviews your ability to pay, income, expenses and asset equity to determine how much it can expect to collect in a “reasonable period of time.”
If the IRS determines it can’t collect the total amount of taxes you owe in a reasonable time, the OIC may allow you to pay less. You can use the OIC pre-qualifier tool to determine if you may be eligible and how much you should offer to pay.
You must include 20% of your OIC amount when you submit your OIC application. If the IRS approves your OIC application, you’ll pay the remaining OIC balance in five or fewer monthly payments.
There are no interest charges or failure-to-pay penalties in an OIC, but there’s a nonrefundable $205 application fee.
Paying your taxes is paramount
Remember, paying your income tax is critical, whether you need to use a personal loan, an IRS installment plan, credit card, HELOC, HEL or OIC. Failure to pay can result in fines and penalties, so choose the option that suits you and get your taxes taken care of.
If you’re struggling to get ahead on your finances, the Tally† credit card debt repayment app can help. Our app helps you manage your credit card payments, and Tally offers a lower-interest personal line of credit, allowing you to efficiently pay off higher-interest credit cards. With these debts in order, paying your income tax on time may be possible.
†To get the benefits of a Tally line of credit, you must qualify for and accept a Tally line of credit. The APR (which is the same as your interest rate) will be between 7.90% and 29.99% per year and will be based on your credit history. The APR will vary with the market based on the Prime Rate. Annual fees range from $0 to $300.