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I recently did a preliminary calculation of my taxes for 2018 and discovered that I am going to owe the IRS about $16,000. I do not have this amount of money in reserve.

My question pertains to the best way to pay this amount. Options as I see them:

  1. Sell an asset to raise the money (such as a car)
  2. Put it on the credit card
  3. Withdraw from 401k to raise funds
  4. Use an IRS payment plan

Unfortunately, #1 isn't a great option (I need my car). So it's going to be something from 2-4:

  1. Credit card. My interest rate on purchases is 18.24% annually. Could work.
  2. Withdraw from 401k. Doing this would put me in the 24% income tax bracket, plus the 10% penalty on the total amount withdrawn, plus the state wants a piece. This amounts to about a 39% hit. This is a terrible idea.
  3. IRS payment plan - I read up a bit on this and couldn't get a good understanding of what the actual costs are. The annual interest rate is 3%, but there are fees and also a late payment penalty of 0.25% per month.
Kat
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Mark
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    Do you have sufficient credit rating to open a new credit card with a 0% promotional APR? 18.24% is completely unreasonable especially on top of 2% up-front for the convenience fee, but a promotional APR can make paying taxes on credit card very reasonable. – Ben Voigt Feb 10 '19 at 01:19
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    Did you have a windfall or are you self-employed and haven't been paying estimated taxes throughout the year? – Hart CO Feb 10 '19 at 02:00
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    @HartCO good thinking - and also have a cold hard think about whether this will happen again in the current financial year. If so, save for it as soon as you can. – Criggie Feb 10 '19 at 05:36
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    Compare 18.24 percent and 3 percent. Compare 39% to 3%. – gnasher729 Feb 10 '19 at 12:44
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    You didn't mention when you will actually have the money (and how solid that plan is). E.g. tax payment on April 15th, money becomes available on April 19th, credit card due on May 10th is a very different calculation from "I have no idea how I'll ever get the money". – user3067860 Feb 10 '19 at 16:15
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    @gnasher729 it's not quite as simple as comparing rates. I also have to consider my ability to pay an additional amount per month. If I were to withdraw the correct amount from my 401k, I'd have nothing to pay off. – Mark Feb 10 '19 at 18:38
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    @Mark how much could you afford a month, safely? – cybernard Feb 10 '19 at 19:26
  • To answer some of the questions above: @HartCO: I took a large early withdrawal from my 401k last year. I had no other way of coming up with the amount of money I needed. – Mark Feb 11 '19 at 14:24
  • @cybernard: with some creative budgeting I believe I could afford about $1400 a month, which would allow me to pay an IRS loan off in about a year. Or less if I pay off half of it to start. – Mark Feb 11 '19 at 14:26
  • An additional option here is a P2P loan. Not sure what sort of interest rate I could get though; these vary widely depending on risk. – Mark Feb 11 '19 at 14:27
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    I paid off a car of 21k (after taxes,warranty, etc) in 4 yr at 400mo. So you should be able to find an affordable loan. Get a 10yr loan pay it off in 4, or etc. Sure interest rates are higher on personal loans, but if you shop around. Maybe get a home equity line of credit, probably get a good interest rate on that. You can even find credit cards with 18 months free balance transfers except for a 2-3% initial fee. After 16 mo @1000 month easy. Even you end up pay 10% apr on the last 2-3k its not that much. – cybernard Feb 11 '19 at 14:36
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    Are you a home owner? Mortgages tend to be a very cost effective loan. – UKMonkey Feb 11 '19 at 17:09
  • @UKMonkey I am a homeowner, but I don't have enough equity to pull out money unfortunately. Agree that this would be a great option. – Mark Feb 11 '19 at 18:53
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    Borrow from your 401K? Rates are low and guess what, you pay the interest back to yourself! No tax or penalties. https://www.investopedia.com/articles/retirement/08/borrow-from-401k-loan.asp – AbraCadaver Feb 11 '19 at 19:01
  • @Mark Have you taken care of the situation that caused you to have to withdraw from your 401(k)? Or is it possible that there will be another situation this year? – shoover Feb 11 '19 at 20:28
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    @shoover. Yes. The expense was for costs related to surrogacy. This was a one-time expense. – Mark Feb 12 '19 at 00:31

2 Answers2

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Of the options you've listed, setting up a payment plan with the IRS is the best, cheapest option. The current interest rate from the IRS is 6%. This interest rate is updated once every three months based on the federal short term rate. The penalty charged is an additional 0.25% per month (roughly another additional 3% per year). This works out to a rate of around 9%, which is much better than your credit card or your 401(k).

You may be able to get a better loan rate by talking to a local bank or credit union. If you can beat 9%, then that would probably be a better option than IRS installments.

However, more important than the interest rate you can get is how quickly you pay it off. Dedicate yourself to eliminating this debt as fast as possible. Work as hard as you can to save up as much as possible between now and April 15 to minimize the amount you have to borrow, and keep working at it afterwards until this debt is paid off.

Finally, there must be a reason that you have found yourself with a large tax bill and no money. Hopefully, you know what went wrong so you don't make that mistake again. If not, be sure to figure it out.

Ben Miller
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    No details yet, but I had read the IRS will negotiate the time for those in this situation, although there may be a limit, like $10K. Edit - The change for 2018 is the 90% threshold for penalty. That has been reduce to 85%, i.e. if one has paid 85% of final tax bill, no penalty. I can't find a change for payment plans. – JTP - Apologise to Monica Feb 10 '19 at 03:06
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    A loan from my 401k is at 6.5% right now and I would pay that back to myself. – AbraCadaver Feb 11 '19 at 21:46
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Ben is right as far as your options. I'd use the IRS payment plan. You're allowed to use a payment plan every few years I believe. I owed around that amount ($18K) and was able to make $2K a month payments. I don't remember exactly what the fees were, but it wasn't much. That allowed me time to make additional income as I'm always paying $20K a year in taxes.

Pay what you can in the next 2 months and get a payment plan. If you're going to be in the same scenario again, start putting back money as you can.

Best of luck.

Richard Hale
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