What to Do When You Can’t Pay Taxes

Can't pay your taxes? Don't ignore the situation. Here are some things to consider as you move forward.

Being unable to pay your taxes can be stressful. I know. I've been there before. When I first started my freelance writing career, I had no idea what I was getting into, tax-wise. And it was rough. I've learned a lot since then—including the available options when you need a little help to pay your taxes.

Options for when you can't pay your taxes

In an ideal world, you'll be able to pay your taxes on time and in full. One reason I set up an S Corp election and started using Gusto for my payroll is that it's much easier to have someone just…handle the taxes.

For every moment you don't send money to the IRS, you're dealing with interest and penalties that just keep adding up. It's even worse if you don't even file your taxes. The penalty for failure to file is a whole other issue.

So, if you can't pay your taxes, look for other ways to get through the situation.

IRS payment plan: the best option

If you owe money on federal taxes, one of your best options is to set up an IRS payment plan. You can set up an online payment agreement based on your situation and what you owe. This agreement is considered a loan, but the interest rate you receive is likely to be lower than what you would see if you paid your taxes using a credit card or some sort of fast-money loan. It might even be cheaper than getting a personal loan at your local bank (double-check rates to be sure).

Most people who owe less than $25,000 can set up a payment plan online without too much trouble. You can even have it automatically deducted from your bank account each month.

State taxes and property taxes

When figuring out how to pay your tax debt to your state or your local government, things can be a little more difficult. You can usually set up a payment plan for state income taxes. I had to do that before when I didn't adequately plan for my tax bill. It's not the ideal situation, but it still costs less than the other alternatives.

Another option is to take out a loan. Some companies provide property tax loans aimed at allowing you to pay off your debt to the local government and then make more manageable payments. However, it's important to note that these types of loans can be very expensive, coming with a high interest rate. As a result, it makes sense to double-check for installment plans. And don't forget that you usually have to secure the loan with your home, so you could potentially lose your home anyway if you can't make your loan payments.

Other options for paying state and property taxes, if an installment plan through the taxing authority isn't available, include credit cards and other types of loans. If you have the ability, it might even be worth it to borrow from friends or family to pay your taxes. They might offer much better terms overall.

Other loans

Don't forget that other loans might be available. If you have a 0% APR introductory rate on a credit card, you might be able to pay your taxes that way. You save on interest, and you might even get reward points. You need a plan to pay off the debt before the promotion for the interest rate ends. Otherwise, you could be in big trouble when the higher APR kicks in.

A low-rate personal loan might also be helpful. Check to see if your credit score is high enough to qualify you for a rate that's lower than what you're paying with an IRS payment plan. That can be a way to get the tax debt taken care of while making manageable monthly payments.

Sell investments

If you have investments, you might be able to sell some of them to pay your taxes. In a taxable account, look for some investments that have lost value. Sell them at a loss, get a tax deduction for your trouble, and then put the proceeds toward your taxes. When you sell for a gain, be aware that you'll likely have to pay taxes on your earnings next year, so that could increase a potential tax bill later.

Another strategy might be a 401(k) loan if your employer offers the choice. You're borrowing from yourself, so every payment you make goes back into your retirement account. However, you need to be aware of the rules and risks of borrowing from your retirement investment account. Plus, you're missing out on potential gains as long as the money is no longer in your account.

Be aware of the cost

Whenever you take advantage of loans or sell investments, you need to be aware of the cost. This is especially true when it comes to “fast money” loans. Whether you are trying to ease your cash flow or whether you just want to pay your taxes, getting an outside loan to make it happen can be costly. You might end up paying many times the amount you borrow in interest rates.

When you sell investments, you need to know that there will be an opportunity cost involved, as well as potential costs associated with capital gains taxes.

Any type of financial decision or loan requires tradeoffs. If you just need to make something manageable, and you are more concerned about cash flow and affordability, you might think it's worth it to pay a higher cost. On the other hand, if you want to pay as little as possible, you need to find a way to pay off your tax debt as quickly as possible.

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