Feeling stressed about your tax debt? You’re not the only taxpayer in that boat.
According to U.S. News, 1 in 5 Americans with tax debt feel “extremely stressed” right about now. And who can blame you for feeling this way? Rising costs over the past year have taken their toll on wallets everywhere.
But, when you’re deep in tax debt, I want you to remember that you actually DO have options. In this case, let’s start with the ones immediately available: Pay the IRS directly (payment plans as an option) or paying off IRS debt all at once with a loan.
While bank loans and lines of credit would answer some of the immediate stress of that tax debt hanging over your head, they do come with a price.
That’s when you ask: Is the price worth it?
That depends on your situation. Just because you’re taking care of one thing, you can’t ignore what new things you’re getting into.
Here’s what I mean. Let’s suppose you don’t want to jump right into your first option of an installment payment plan with the IRS. You also don’t want to whip out your credit card where interest rates could be up around 20% (yikes!).
So, you need to really need to weigh the pros and cons of option 1: tax penalties, interest, and the pressure of paying off IRS debt against option 2: taking on various types of loans.
Let’s take a walk through what’s available out there for you on the loan front… and empower you to alleviate some of the stress
This type of loan is probably the first solution that may come to mind when you consider paying off IRS debt with borrowed money. You generally get personal loans through banks, credit unions, and online lenders; *usually* put up no collateral; and pay the loan back regularly over time.
Pros: You can get this money quickly — if you qualify. The repayment schedule will be predictable — and your interest, though still stinging, may come in at less than an IRS payment plan and almost surely less than putting the debt on your credit card. Most personal loans have no early-payment penalties, either.
Cons: Unsecured personal loans are usually pricey, particularly in interest rates that are higher than those of other loans. If your credit score is good, you can probably get away with a low two-digit percentage. A bad score, on the other hand (say, lower than 630), could get you socked with interest as high as almost a third of the amount that you borrow.
Because the loan is unsecured, lenders (including Connecticut ones) may limit what you can borrow or give you less time to pay the loan back. They’ll also examine your finances a lot more closely than with other kinds of loans.
A question worth asking: Can you get a loan big enough to cover your entire tax bill? A personal loan also dings your debt-to-income (DTI) ratio, unless your income increases at the same time you take out the loan. Your DTI impacts your ability to get a mortgage or other loans.
With personal loans, try to pre-qualify with multiple lenders so you can comparison shop for rates and repayment plans.
Home-equity loan or line of credit
When considering paying off IRS debt with this kind of loan, you put up your property to get the money to pay off your taxes.
Pros: Are you okay with having debt tied to your home? (Remember, you probably already have a mortgage and are already comfortable with the concept.) If so, interest rates for this are usually much lower than what the IRS or your credit card will charge.
Cons: You have to have substantial equity in your home already. This type of loan can also take time to set up; you’ll need your home appraised, and your lender may hit you with upfront fees for that plus a credit report and loan origination, among others.
And we repeat the question, which is a big one: Are you okay with having debt tied to your home?
Liquid asset-secured financing
Yet another paying-off-IRS-debt loan option: You put up your marketable securities to secure a line of credit.
Pros: These loans can be put together quickly. Setting one up also incurs no costs or fees upfront, and you have no payments other than the interest as long as the loan is outstanding. It’s conceivable that market returns might even beat your interest rate, and there’s no payback schedule, either.
Cons: Yes, there’s no schedule — but your collateral is tied to the volatility of the stock market. If the market drops hard and your portfolio takes a sustained wallop, you may have to mortgage even more assets. You can only borrow what your portfolio will back up. And if you decide to sell assets to avoid mortgaging them, you could trigger a capital gains event and more tax debt.
Assuming your plan allows loans, this strategy dips into the portion of your 401(k) retirement account that comprises your contributions and the contributions of your employer (that now belong to you).
Pros: You can generally borrow well into the five figures. Interest charged on this loan is deposited back into your 401(k). You have up to five years to pay back the loan.
Cons: Your nest egg diminishes.
Repayment has to be regular, generally quarterly. If you lose or quit your job, you’ll have to repay the remaining balance by the tax deadline of the following year. Default on repayment and the leftover balance will be treated as a withdrawal on which you’ll owe income taxes and a possible 10% early-withdrawal penalty.
As you can see, there’s definitely math to do when deciding what option is best for you. Fortunately, that’s what I’m here for. If you’re looking for creative ways to pay off tax debt that won’t come back around to bite you, let’s look at your situation together: waterbury-cpa.com/make-an-appointment/
In your corner,
Emelia Mensa, CPA