IRS Taxes Owed: Request A Payment Plan or Borrow the Money?

Each year thousands of individuals are left owing the IRS taxes they cannot pay when they complete their tax return. If you are facing severe financial hardship (e.g. prolonged unemployment, bankruptcy), you have a few feasible options: either you request an IRS Installment Agreement (IRS Payment Plan), pay your taxes with a credit card, or you obtain a loan from a financial institution (e.g. bank). In order to make the best decision, you need to consider not only how quickly you can pay back the taxes, but also the the corresponding interest rate for each option, as well as other details. Unfortunately, there is no clear cut solution, as it will depend on your situation. If you realize that borrowing the money or requesting a payment plan would leave you no cash leftover for monthly living expenses, you should look to settle for less with the IRS through the use of a Partial Payment Installment Agreement or an Offer In Compromise.

Tax Forms

What If You Can Pay the IRS In a Short Period of Time?

Assuming you will have the money in 120 days, you have two viable options. You could put your taxes on a credit card or you could call the IRS at 1-800-829-1040 to inform them that you will be paying in 120 days or less. In deciding your best option, understand that if you decide to pay the IRS in 120 days, you will incur a 4% interest rate (compounded daily), as well as .5% underpayment penalty (compounded monthly) on the unpaid amount. In contrast, if you pay your taxes with a credit card, you will most likely incur two fees. One is a convenience fee of 1.95% to 3.89%, and the other is your APR or interest rate for carrying a balance. Therefore, in deciding which route is best here, you need to weigh the total cost of taking a 120 day loan with the IRS (the interest and penalty) versus your credit card company (convenience fee and any applicable interest rate for carrying a balance each month).

What If You Will Need More Than a 120 Days to Pay Your Tax Bill off?

If you need a long-term payment agreement to pay of your taxes then you will be weighing the cost of an IRS Installment Agreement and a bank loan.

An IRS Installment Agreement allows you to pay taxes owed to the IRS over a series of monthly payments that can last from 3-5 years depending on the amount owed. If you owe more than $10,000, an IRS Installment Agreement can be usually as long as 60 months, otherwise, it is typically 36 months. It carries an interest rate (currently 4% compounded daily) as well as a penalty (.25% compounded monthly) for failing to pay in full. The total current nominal yearly interest rate in this case would be approximately 7%.

If you cannot pay back the IRS in a few months, and you cannot not obtain a more favorable interest rate (than roughly 7%) from a financial institution (e.g. bank), then an IRS Installment Agreement looks favorable. However, there are a few other factors to consider here:

  • Make sure to include in your analysis that fact that the IRS charges a user fee for an IRS Installment Agreement. The user fee is $105 dollars for non-direct debit payments, $52 dollars for direct debt payments, and $43 for income levels below the Department of Health and Human Services poverty guidelines. This fee should be compared to any upfront fees for a bank loan or for doing a cash-out mortgage refinance.
  • The IRS’s payment plan interest rate (currently 4%) can fluctuate, as this rate is set quarterly. For individual taxpayers, it is determined by the Federal Short term rate plus 3%. Considering rates are pretty low now, arguably you have more potential for rates to rise as the economy improves.
  • The IRS can issue a tax lien against you, which is stake or claim on your property by the IRS. Therefore, if you are looking to sell your house, finance a car or house, then you may want to consider borrowing because the negative effects of a tax lien on your credit can be substantial.

Setting Up an IRS Installment Agreement

If you decide to setup an IRS Installment Agreement, here is how you can do it:

  • If you owe $25,000 or less to the IRS, use the Online Payment Agreement Application or use file out Form 9465 and attach it to your tax return.
  • If you are requesting an Installment Agreement above $25,000, fill out a Collection Information Statement (form 433-A) and include that with form 9465.
  • When calculating your minimum monthly payment, take the total amount you owe and divide it by 30 if you owe $10,000 or less, otherwise, divide by 50.
  • Be sure to include the appropriate user fee (discussed above) with your your first month’s payment

In summary, if your total cost of financing your taxes through a bank loan is equal to your cost of financing your taxes through the use of an IRS Installment Agreement, it is recommended that you pursue a bank loan based on the simple fact that IRS interest rates are more likely to rise. Moreover, if you are going to be making some financial decision in the near future that requires your credit to remain strong, a bank loan is recommended, as a tax lien can severely hamper your credit report and score.

This post was written by Manny Davis. Manny is President of Back Taxes Help, LLC, a firm that specializes in helping taxpayers pay back taxes and resolve major irs tax problems. Visit BackTaxesHelp.com for more information.

Photo credit: Salem (MA) Public Library

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