Most people are up to date on their taxes, but there’s little agreement on the best way to come up with the cash among those who aren’t.
A new GOBankingRates survey of more than 1,000 adults found that roughly 77% of people don’t owe anything to the IRS — and the 23% who’ve fallen behind have varied strategies for how they plan to pay.
If you owe back taxes, the worst thing you can do is ignore the problem as penalties pile up, interest accumulates and the IRS loses patience. In the end, you’re going to pay one way or the other — but how you pay can have implications on your finances that go way beyond an old tax bill.
Empty Your Savings, String Out Payments or Borrow Money? Finding the Least Lousy Option
The largest percentage of those with past-due tax bills — a little under 7% of all survey respondents — plan to set up a payment plan with the IRS. Another 5% will use their savings or emergency funds to pay it back all at once, followed by 4.5% who will take out a personal loan or use a credit card, 3.5% who haven’t decided yet, 2.6% who will borrow money from family or friends and less than 1% who have simply given up on ever being able to pay.
If You Have the Cash To Cover It, Grab Your Checkbook
The 5% who plan to tap their savings to pay their balances in full are in the best possible position. Every other option involves interest charges — unless a friend or family member loans you money for free, which comes with its own risks and headaches that you’ll read about shortly — and less interest is always better.
“Paying any bill with the smallest financing charge possible is best,” said Laura Adams, MBA, an award-winning personal finance author and expert with Finder. “If you have an emergency fund, use it to pay your taxes.”
It’s important to note that some experts advised against fully depleting your savings to pay your taxes because that could leave you with nothing in the face of an emergency. In that case, you might pay as much as your emergency fund can tolerate to reduce your interest-accruing principal and then borrow the rest or string it out in payments.
Others think that if you have the money, it’s better just to pay up and get the IRS off your back.
“I’d say the best way would be using your savings, then rebuilding from there,” said Kendall Meade, certified financial planner at SoFi. “However, some people may not have a big enough savings to cover the taxes they owe.” In that case, the name of the game is minimizing finance charges.
Payment Plans: The IRS Charges Interest, But Not As Much as the Bank
The IRS allows qualifying taxpayers who owe less than $50,000 to pay their balances in monthly installments for up to 72 months.
“Setting up a payment plan with the IRS is the most sensible approach when owing taxes,” said Alec Kellzi, a licensed CPA who counted more than 30 Fortune 500 companies among his client list during his time with Big 4 accounting firms PricewaterhouseCoopers and Ernst & Young. “It allows you to spread payments over a manageable period, reducing the financial strain. This option generally doesn’t involve high interest charges, making it more financially responsible.”
It’s also more responsible because the alternative is taking on debt to pay a debt. “Setting up a payment plan with the IRS is generally a more beneficial option than borrowing from family or friends, taking out a loan, or using a credit card,” said TaxBuzz founder Lee T. Reams, Sr., a nationally recognized tax expert who manages his own practice with more than 600 clients and has served on numerous professional boards. “Payment plans with the IRS are structured to accommodate the taxpayer’s financial situation, making the circumstances more manageable. The IRS understands that people need a structured approach to resolving tax debt. Payment plans also avoid straining personal relationships or incurring high interest rates often associated with loans or credit card debt.”
If You Must Borrow Money, Choose the Cheapest Loan
The remainder will take out a personal loan, use a credit card or borrow money from loved ones to pay their back taxes. With the exception of dangerous alternatives like payday loans, using a credit card is the worst choice of the bunch — according to Forbes, the average card now charges a brutal 28.05% interest.
Personal loans are typically more forgiving than plastic but more expensive than the interest the IRS charges for its payment plans, which is the federal short-term rate plus 3%.
You might be able to convince family or friends to float you the money, maybe interest-free, but borrowing from loved ones can strain relationships and cause social friction.
“If you have family or friends who are willing to loan you the money, this can be good because you may not owe interest,” said Meade. “However, it is very important to establish guidelines as you don’t want to put tension on these relationships. I recommend talking through expectations beforehand — how much are you expected to pay back and over what time period? This can help to avoid any confusion or unmet expectations.”
What You Can Do if You Owe Back Taxes
If you owe back taxes, start by signing up for an account at IRS.gov to view your balance, check the status of payments and learn about your options.
Next, determine how you’ll pay. If your savings are sufficient to settle up without depleting your emergency fund, paying what you owe and getting the IRS off your back interest-free might be the best money you’ll ever spend.
If not, the next best money you can spend might be on the services of a financial advisor who can help you determine how much of your savings to contribute to your tax bill and the best way to source the rest according to your situation.
If you owe less than $100,000, consider seeking an extension. If you qualify, the IRS will grant you 180 days to pay your balance in full. No monthly payments are required, but your balance will accrue interest, so paying as you go is better.
If you can prove financial hardship, consider requesting an offer in compromise that convinces the IRS to accept less than the amount you owe. Finally, consider enlisting the services of a company like Tax Group Center or Tax Relief Advocates, which work with the IRS to lower your taxes and arrange a settlement plan that you can afford.
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