Can You Use a Personal Loan for Tax Debt?

Published on: March 13, 2024

Are you facing the daunting challenge of tax debt and exploring the possibility of securing a loan to alleviate your tax burden? You're not alone in this predicament, and the good news is that there are several options available to you.

Key Takeaways

Taking out a personal loan to pay your taxes can be a viable option if you've exhausted other avenues and can afford the monthly payments. It can help you avoid IRS penalties and manage your tax bill more effectively.
While using a personal loan can prevent IRS penalties and provide manageable repayment terms, it can also lead to additional debt and possible loan denial. It's essential to weigh these factors carefully before deciding.
If a personal loan isn't the right choice for you, there are several alternatives to consider, such as IRS payment plans, using a credit card, borrowing from a 401(k), or seeking financial assistance from family and friends.

Should You Take Out a Personal Loan To Pay Your Taxes?

Yes, you may want to consider taking out a personal loan to pay your taxes if you have exhausted other options and can afford the monthly payments.

Personal loans can make it easier to cover your tax bill, allowing you to pay off what you owe on time, and potentially preventing you from getting fined by the tax office. They tend to be quick, simple, and effective, so many people consider this strategy, although it is not the only option.

If you want to learn more about taking out personal loans or you want to start the process, you can get in touch with Simple Fast Loans, and we’ll be glad to give you more information about online personal loans.

Personal loan and taxes

Pros and Cons of Taking Out a Personal Loan To Pay Taxes

There are various pros and cons associated with using a personal loan to pay off your taxes, with the biggest advantage being that you won’t owe money to the IRS and you won’t face any penalties for late payments.

Pros

Avoid IRS penalties. By using a personal loan to pay off your taxes, you can avoid penalties and interest charges that the IRS would impose for late payments.
Manageable repayment. Personal loans allow you to repay the amount gradually, typically in monthly installments, making it easier to budget and manage your finances.
Preserve credit score. Paying your taxes on time with a personal loan can help maintain or improve your credit score, as it demonstrates responsible financial behavior.

Cons

Additional debt. Taking out a personal loan adds to your existing debt burden, which could strain your finances if you're already struggling to meet other financial obligations.
Possible loan denial. Depending on your creditworthiness and financial situation, you may not qualify for a personal loan or may only qualify for a loan with unfavorable terms.

Ultimately, the decision to use a personal loan to pay your taxes should be based on your financial circumstances and the overall cost-effectiveness of this option compared to alternative payment methods.

Risks of Taking Out a Personal Loan To Pay Your Taxes

The risk of taking out a personal loan to pay your taxes is that you may not be able to pay the loan back in time. This can have a significant impact on your credit score and may lead to a variety of problems. You should therefore make sure you can pay back a loan if you’re going to take one out.

What Happens If You Can’t Pay Your Taxes?

If you cannot pay your taxes, the first thing you should do is contact the IRS to discuss your situation. Do this as soon as possible when you realize that you are not going to be able to pay.

Penalties and interest. The IRS will add penalties and interest to your unpaid taxes. These extra charges can add up quickly, making it harder to catch up.
Tax liens. The IRS might place a lien on your property, like your home or car. While this doesn't mean they'll take it away, it can make things complicated if you want to sell or refinance.
Seizure of assets. In rare cases, the IRS could take your assets to cover your tax debt. This is usually a last resort and doesn't happen often.
Legal action. If you ignore your tax debt, the IRS could take legal action. This could lead to a court judgment against you, which can hurt your credit and finances.
Continued collection efforts. The IRS will keep trying to collect your tax debt until it's paid off. They might take money from your paycheck, tax refunds, or use other methods to collect what you owe.

Most importantly, you don’t want to ignore the federal government, and it is in your best interest to contact them and resolve any tax debts.

Alternatives To Using a Personal Loan To Pay Taxes

There are several alternatives to using a personal loan to pay your taxes, so let’s explore these next.

IRS Payment Plan

To help out people who cannot pay their taxes all at once, the IRS does offer payment plans, and these are well worth considering if you are struggling to make your payment. There are two options; there’s the long-term installment plan or the short-term installment plan. Let’s understand both of these.

Full Payment Within 120 Days

The short-term installment plan is paid off within 120 days, so if you only need a bit more time to cover your taxes, you can opt for this. It’s intended for people who can pay off their taxes fairly quickly, and it may be the better option if you think you can pay the taxes off soon.

You won’t need to pay fees to set this plan up, but you will be charged penalties and interest on the account until it has been completely paid off. If it’s possible to pay your debt off in less than the 120-day period, you should do so.

Installment plan

An installment plan may be suitable if you need more time to cover your debt. You will need to set this up with the IRS, including paying a $225 setup fee, as well as the penalties and accruing interest. That makes this method a less desirable one, but it may still be worth considering if you are struggling with your tax bill.

You will need to tell the IRS how much you can pay off each month, and they will either deny or approve the request. If it’s approved, you’ll be able to make the payments over the set period, gradually reducing what you owe.

If you’re a low-income taxpayer, the IRS may be able to waive the setup fee, so it’s worth discussing this with them if you’re struggling to cover it.

Credit Card

Another approach for covering your taxes is to use a credit card. If you can qualify for a credit card with a high enough limit and low interest, this could be a better option than one of the IRS’s payment plans. You will still pay fees, but some may be tax deductible.

This approach is often more flexible and the monthly payments are likely to be lower, but you will need to look at what rates you can get. If your credit rating is poor, it’s probably not going to be an attractive route to go down. You should weigh up the pros and cons carefully before deciding if this is right for you.

401(k) Loan

If you have a 401(k), you may be able to take out a 401(k) loan. This means dipping into your retirement fund, to pay it back. You should be aware that this kind of loan does still accrue interest, so it’s not a “free” loan.

You can take out up to 50 percent of what’s in the account, or $50,000 (whichever is the lower amount). If you’ve got $30,000 in your account, for example, you’ll be able to withdraw $15,000. You will usually have up to 5 years to repay this money, but you’ll need to check the terms and conditions to know for sure.

It’s important to be aware that these loans do include penalties if you fail to repay the money, and will usually be dependent on your employment. If you leave your job, you will be required to repay the loan more quickly.

Make sure you fully familiarize yourself with the pros and cons of 401(k) loans before you consider taking one out to pay your tax bill.

Borrow from Friends or Family

Another method that you may wish to consider is borrowing money from family or friends. This option is preferable for many people, because it can be arranged informally, and you may not be required to pay interest or fees. However, it is important to be aware that this approach does have some potential drawbacks.

For example, if you can’t pay the money back promptly, you may find that this spoils your friendship or puts stress on your family. If the other person is counting on you and you struggle to pay the loan back, this is often problematic.

It’s a good idea to draw up a written agreement that talks about fees and interest so that you can refer back to this. You should also make sure you have a plan for repaying the person who has lent you money, with an accurate idea of where the money will come from and how long the repayment will take.

Graphic for pros and cons of personal loans and taxes

What Other Ways Can I Pay My Tax Bill?

There are a few other options when it comes to financing a tax bill, so let’s check these out next!

1. Use a Home Equity Loan To Pay Taxes

Another method for covering your tax bill could be to take out a loan or a line of credit against your home, assuming you are a homeowner. This can be an effective way of leveraging money, but it does have some drawbacks that need to be considered first.

One of the biggest is that this kind of loan usually takes time to set up, and you’ll have to get your home appraised by the bank before you can borrow money on it. This may take time, which might not work for you if you’ve got a tax bill waiting to be paid. However, if you can wait for the money, this could be a viable option.

Some people find this more comfortable than owing other kinds of debt and therefore prefer to take home equity loans.

2. Take Out a Personal Loan To Pay Taxes

A personal loan is another method that you can use to cover your taxes, and many people turn to this one, especially when they have tried all of their other options. If you’ve got a low credit score and you can’t get other kinds of loans, you might want to consider this.

It is important to weigh up the fees and other loan costs before you decide whether this is right for you. Calculate which of these approaches will allow you to pay the least overall, and you’ll know what’s best for you.

3. Liquidate Assets To Pay Taxes

Another alternative is to use liquid assets to pay for your taxes. This involves using your portfolio of marketable securities to get a line of credit from a lending company. How much you can borrow will depend on what your portfolio will support, so this won’t be right for everybody, but it’s worth considering if you think it could work for you.

If you do opt for this method, you won’t have to pay any fees or other costs just for setting up the line of credit; you will only pay money for what you use. If you take out more money, you will need to pay more, but this can be an inexpensive option overall, and many people choose it.

Not everybody will be able to get a line of credit, but if you can, this is worth considering as a way of borrowing money. You can pay the money back when it suits you, rather than being under pressure to repay it quickly, so if you’ve got a good portfolio, this is a viable option.

If you owe money on your taxes, you have quite a lot of options for dealing with this, including raising money from family and friends, borrowing from a 401(k), using a credit card, taking out a loan, or working out a payment plan with the IRS. Carefully review all of these methods before you decide which is right for you.