What is the best way to pay large tax amount owed to IRS?

Question

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:

2. Credit card. My interest rate on purchases is 18.24% annually. Could work.
3. 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 Doing this would put me in the 24% income tax bracket, plus the 10% penalty on the total amount withdrawn, plus the state wants a piece.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.
4. 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.

Answer 1

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.

Answer 2

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.