If the number on line item number 76 of your tax return, "Amount You Owe" gives you heart palpitations, don't despair. The Internal Revenue Service (IRS) may be willing to work with you as long as you stay in contact and take the necessary steps to get your tax bill paid.
What are the steps you can take to pay the IRS if you don't have cash readily available? The best answer for many taxpayers in this situation may come as a surprise - consider a home equity loan or line of credit (HELOC).
Avoid tax penalties
Even if you don't know exactly how you'll pay off your tax debt, you should still be sure to file on time. Not filing on time can be costly. For example, the maximum penalty for failure to file and pay is 47.5% (22.5% late filing and 25% late payment) of the taxes due.
The IRS isn't shy about tacking on penalties and interest for failing to file, and for back taxes. For instance, the failure to file penalty is 5% of the unpaid taxes for each month or part of a month that a tax return is late.
Interest accrues on the unpaid balance at a rate of 3% and compounds daily from the due date of the return.
At least four options are available to you for paying outstanding tax obligations, each has advantages and drawbacks.
IRS installment payment plan
The IRS offers payment plans. You can request an installment payment plan for your tax debt by proposing a monthly payment amount to the IRS. In a perfect world, you'll be able to agree to a monthly amount that's acceptable to the IRS, as well as within your budget.
As with most other repayment options, there are downsides to an IRS installment plan. For example, there's a setup fee charged for installment agreements. IRS installment plan fees can vary but can be anywhere from $43 to $225.
Use a home equity loan to pay taxes
You may be surprised if you are wondering, "Can you use a home equity loan to pay taxes?" Getting a loan to pay off the IRS may sound unappealing, but the IRS advises that one of the best solutions for paying off tax debt is a home equity loan. According to the IRS Topic 202: "You should consider financing the full payment of your tax liability through loans, such as a home equity loan from a financial institution."
Unlike other forms of borrowing, home equity loans can have the added potential bonus of tax deductiblility, but only to buy, build or substantially improve the home against which the loan or line is secured. As such, you won't be able to get a tax break on the interest you will pay if you use equity to cover your tax bill, but you can still enjoy easy access to relatively low-cost funds.
Fees for setting up a home equity loan can be minimal. If you have good credit and some equity in your home, you may be able to get a home equity line of credit (HELOC) at an affordable interest rate, perhaps around 5 percent. When you can find them, fixed rate home equity loans are typically in the 7 percent and under range today.
Getting a home equity loan may result in lower payments than the IRS can offer in an installment plan. Review out guide to home equity loans to fully understand how they work.
Getting a loan to pay off IRS
You may be able to get a personal loan for paying your tax debt. Personal loans to pay taxes off are generally obtained from a private lender and are typically not tax deductible.
The downside to a personal loan is that most require interest payments so you should expect to pay more than you owe in taxes. The interest rate on a personal loan, however, is likely to be lower than IRS interest and penalties.
Many personal loans come without any prepayment penalties. This could mean no extra cost if you're able to pay off your loan early to save on interest.
Pay the IRS bill with a credit card
Although you can't use a credit card when it comes to a downpayment on a new home, the IRS accepts all major credit card payments for taxes owed. One possible advantage is that if you use a rewards credit card, paying your taxes may earn rewards such as cash back or travel bonuses.
The catch to using a credit card is that the IRS charges you a processing or "convenience" fee. Another concern is that if you are unable to pay off the credit card balance quickly, you may have to pay higher interest than in other loans to pay off taxes. The expected time frame for paying off your credit card, and the associated interest charges, must be factored into whether or not using a card is a reasonable option.
Paying off your IRS tax debt
Owing money to the IRS can be intimidating and scary. Fortunately, you have options to resolve the issue with some planning. If IRS installment payments are uncomfortably high, and you have some equity in your home, using a home equity loan to pay taxes may be a good option. Personal loans can also be considered, and credit cards might be used as a last resort.
Whichever option you choose, be sure to address the problem promptly. The IRS isn't likely to just go away. In fact, they are more likely to slap a lien on your home -- a public record that can damage your credit. You may not be able to refinance your home loan or sell your property or without first clearing this obligation.
Updated by Craig Berry, March 19, 2018
More help from HSH.com
Home equity borrowing basicsOur new Guide to Home Equity Loans and Lines of Credit (HELOCs) starts here.
Accessing your home equityThis first article of Section II of our Guide to Home Equity Loans and Lines of Credit looks at the various ways lenders allow you to access your home equity, and discusses key differences between loans and lines.
Determining how much home equity you can borrowArticle 3 of Section I of HSH.com's Guide to Home Equity Loans and lines of credit, we explain how to reckon your equity stake and discuss criteria lenders use to decide how much they'll lend to you.
Using home equityThis is the second article within Section I of HSH.com's Guide to Home Equity Loans and Lines of Credit. In it, we discuss some common and valuable uses of your home's equity, and some you may want to avoid.
Understanding home equityThis is the first article within Section I of HSH.com's Guide to Home Equity Loans and Lines of Credit. In it, we explain what home equity is, how you get it, how you can build it and why you should protect it.