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Can you use a personal loan for taxes?

personal loan for taxes

Using personal loans for unpaid taxes is one of the easiest ways to take care of any balances you owe the IRS at tax time, but is this funding option the right choice for you? 

Here, you’ll learn about how using personal loans for taxes works, the potential expenses, and what your other payment options are. 

Are Personal Loans Taxable Income?

In addition to a federal tax return, some states require residents to pay state income taxes as well. There are nine states that do not require an income tax return from their residents. They are: 

  • Alaska.
  • Florida.
  • New Hampshire.
  • Nevada.
  • South Dakota.
  • Tennessee.
  • Texas.
  • Washington.
  • Wyoming.

Many borrowers may be pleased to hear that there are virtually no tax implications when it comes to personal loans. While personal loans may be used to supplement income, they are fortunately not considered taxable income. This is because borrowers end up paying their loan balance back, so installment loans on their own are not considered income that is taxable. 

How Does Getting Personal Loans To Pay Taxes Work?

Borrowers may access personal loans from a financial institution such as a:

  • Bank
  • Direct lender
  • Credit union

While banks and credit unions sometimes have strict requirements when it comes to qualification for a personal loan, private direct lenders may be much more flexible. To seek out a personal loan for paying taxes, first, fill out an online application with a lender suited to meet your needs. 

Before filling out an application, do some research about the different lenders and personal loan products. This will give you a better idea of what kind of loan amounts, interest rates, and payback terms are available to you. Once you find a lender that looks like a good fit, you can go ahead and submit an application! 

Upon approval, your lender will request a few core documents from you. They may include: 

  • Driver’s license or government-issued photo ID. 
  • Bank account information (account number and routing number). 
  • Proof of income. 
  • Proof of residency. 

After your lender processes your documents, they will send you a loan agreement to sign. Once you have read and understand the terms of your loan, you can sign your contract and receive your approved personal loan funds!

Pros and Cons of Using a Personal Loan for Your Tax Bill

Before submitting an application for a personal loan to use on your tax bill, consider the potential advantages and disadvantages. 

PRO: Predictable Monthly Payments

Personal loans typically come with a fixed interest rate, which means monthly payments stay consistent and predictable. When you are able to easily anticipate what you’ll be responsible for paying each month, staying on top of personal loan installments can be easy and stress-free. 

PRO: Unsecured Loans Don’t Require Collateral

Using a personal loan to pay your tax bill also doesn’t require borrowers to give up anything as collateral. Secured loans like home equity lines of credit or auto title loans require borrowers to offer either their home or their vehicle as collateral. Then, should they miss a payment or default on their loan, borrowers run the risk of their lender repossessing whatever property they used as collateral. Personal loans allow borrowers to forgo that risk altogether! 

PRO: May Cost Less Than an IRS Payment Plan

While the IRS does offer payment plans for individuals and businesses, the interest rates can be quite high. Since interest rates make a huge difference in determining how much borrowers end up paying overall, it’s important to get the best deal possible. Depending on your financial situation and credit history, you may be able to get lower interest rates with a personal loan. 

CON: Acquiring Debt

While receiving a personal loan can be a great way to pay taxes, it will also add to your debt-to-income ratio. Your debt-to-income ratio refers to how much money you make compared to your outstanding balances. The more debt a consumer has, the more unbalanced their debt-to-income ratio becomes. Before you apply for a personal loan, consider how much debt you currently have. 

CON: Credit Score May Drop Temporarily

When you fill out an application for a credit card, personal loan, or any other line of credit, lenders will request a hard credit pull from your credit profile. Hard credit pulls are tracked and recorded for your credit reports and have the ability to bring down your overall credit score. That being said, try to apply to just one or a very select few personal loan lenders when looking for funding. 

What Happens if You Don’t Pay Your Taxes?

If you find yourself in a situation where you owe the IRS money after doing your taxes, try to pay what you owe as soon as possible. Otherwise, if you are late filing taxes or neglect to file/pay at all, you may run into one or more of the following tax penalties:

Penalty TypeDescription
Information return penaltyApplied when citizens fail to file, provide inaccurate or incomplete information on their return, or payee statement by the designated due date.
Failure to file penaltyImposed on citizens who do not file their tax returns on time.
Failure to pay penaltyIncurred by citizens who owe taxes and do not pay them on time.
Accuracy-related penaltyApplied when citizens fail to claim all required taxable income or incorrectly claim a tax-deductible or credit they do not qualify for.
Erroneous claim for refund or credit penaltyLevied when citizens attempt to submit excessive claims for refunds or credits without reasonable cause.
Failure to deposit penaltySimilar to a failure to pay penalty, it applies when citizens do not pay their required employment taxes in full or on time.
Tax preparer penaltyApplicable to citizens filing taxes on behalf of others if they do so incorrectly.
Dishonored check penaltyImposed when citizens submit a bounced check or a check that their bank does not honor.
Underpayment of estimated tax by corporationsApplied to business owners who fail to pay taxes correctly for their business or corporation.
Underpayment of estimated tax by individualsImposed on individual citizens who do not pay their estimated taxes appropriately.
International information reporting penaltyLevied on citizens with foreign source income or financial activity who do not adequately report it on their taxes.

Alternative Payment Methods When You Owe Taxes

If you have decided that a personal loan is not the right choice for you when paying back your taxes, there are also other options to consider. 

IRS Payment Plan

Whether you are paying taxes as an individual resident or on behalf of your business, there are IRS payment plans to help take care of your tax bill. For individuals, there are long-term and short-term payment plans. For businesses, there is a long-term payment plan.

The quickest and most efficient way to apply for this plan  is online. If you choose to apply by mail, over the phone, or in person, you may have to pay an extra fee.  

Individual Short-term Payment Plan

Citizens who owe $100,000 or less on their tax return may be eligible for a short-term IRS payment plan. With this payment plan, there is a $0 startup fee, but taxpayers will have to pay back any penalties and/or interest they may accrue during their payment terms. 

Individual Long-term Payment Plan

Citizens who owe $50,000 or less on their tax return may be able to take advantage of a long-term payment plan. With this type of repayment plan, there is a $31 startup fee, and, just like the short-term plan, citizens may also have to pay for penalties and/or interest. But, if you are a low-income taxpayer, you may be able to have the startup fee discounted or removed.  

Business Long-term Payment Plan

Business owners who have appropriately filed all their required tax documents and end up owing $25,000 or less in taxes, penalties, and interest combined may be eligible for a long-term IRS payment plan. Similar to the individual long-term plan, taxpayers will have to pay a $31 startup fee as well as any additional penalties and/or interest they acquire until they pay back their balance in full. 

Other requirements business owners will need to submit when they apply for a business long-term payment plan are: 

  • Their EIN (employer identification number).
  • The date and year their business was established. 
  • Caller ID (from notice). 

If the IRS examined a business owner’s tax return but didn’t send a balance notice, they will also need the following: 

  • Your most recent business address.
  • Total balance due. 
  • Specific tax documents that were filed/examined.
  • The time period when the business owner filed their tax documents. 

FAQS

Can I use a loan to pay taxes, and is this a common practice?

Yes, you can use a loan to pay taxes. It’s a viable option for many people who need to cover their tax bills but don’t have the necessary funds readily available. Just ensure you understand the loan terms and can manage the repayments.

What is an origination fee, and will I encounter this when I borrow money for taxes?

An origination fee is a charge by the lender for processing a new loan application. It’s typically a percentage of the total loan amount. When you take out a personal loan to pay taxes, you might encounter this fee, depending on the lender’s policies.

How does paying taxes with a personal loan affect my future income tax filings?

Using a personal loan to pay taxes doesn’t directly affect your income tax filings, as the borrowed amount isn’t considered income. However, it’s important to manage the loan responsibly, as failure to repay can have financial consequences that might indirectly affect your future tax situations.

Do all financial institutions offer personal loans for the purpose of paying taxes?

Many financial institutions offer personal loans that can be used for various purposes, including paying taxes. However, the availability, terms, and conditions of these loans can vary between lenders. It’s advisable to shop around and compare offers to find the best fit for your needs.

If I’m unable to pay taxes and need to borrow money, what should I consider before taking a personal loan?

Before taking a personal loan to pay taxes, consider the loan’s interest rate, repayment terms, and any fees like origination fees. Also, assess your ability to make the monthly payments and how the loan will impact your overall financial situation. It’s crucial to borrow responsibly to avoid further financial strain.

The Bottom Line With CreditNinja: Using Personal Loans for Taxes

Overall, using a personal loan when you owe money on your taxes can be a quick and easy financial solution. You can also seek assistance from a tax professional to discuss your other options, like IRS payment plans or possibly extending the deadline on your tax return. 

References:

  1. Online Payment Agreement Application | Internal Revenue Service
  2. Penalties | Internal Revenue Service

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