Though the majority of people who file tax returns wind up with a refund from the IRS, those who end up owing taxes often struggle to pay their bills. In fact, tax-prep company Jackson Hewitt recently conducted a survey with ResearchNow and found that nearly 36% of filers owed the IRS money this year.
Unfortunately, a large number of those who underpaid their 2018 taxes couldn't simply pay their tax debt with savings alone. Here's what filers did to cover their shortfalls:
Method of Paying Tax Debt
Percentage Who Paid This Way*
Withdrew money from savings
Used a credit card
Got on an IRS installment plan
DATA SOURCE: JACKSON HEWITT. *The above percentages only include the 36% of filers who owed money, and some may have used a combination of methods.
There's certainly nothing wrong with dipping into savings to cover an unplanned tax bill. After all, that's what that money is there for. What's more problematic, however, are some of the other methods Americans used to tackle their IRS debt.
IMAGE SOURCE: GETTY IMAGES.
The right way to pay your tax debt
If you don't have the money in savings to cover your tax bill, there are options you should pursue before borrowing money or resorting to credit card debt. The latter is an especially unfavorable approach to tackling tax debt because the IRS will automatically charge you a processing fee for the convenience of putting your tax bill on a credit card. Not only that, but the balance you rack up because of that tax debt will be subject to interest -- interest that well exceeds what the IRS will charge you to pay off your debt over time.
The IRS will allow those who owe less than $50,000 in taxes to pay off their debt over time in the form of an installment agreement. Though you'll incur interest on the balance you carry from month to month under such a setup, the rate you'll be subject to will likely be much lower than what your credit card will charge.
Furthermore, any time you carry a credit card balance, you risk bringing down your credit score in the process. That's because credit utilization is a major factor in determining your score. Utilization speaks to the extent to which you're using your available credit, so the higher a balance you carry, the more credit you're using up.
If you owe the IRS so much money that you don't think it's possible to pay it back, you can also make an offer in compromise. By doing so, you're essentially asking the IRS to settle for a lower amount than what you owe. Much of the time, this approach won't work, but if you can prove that your tax debt really isn't payable, it might. Though you can make an offer in compromise on your own, you can also enlist the help of a tax professional to help present your case.
Of course, there's also the option to take out a personal loan and use it to pay your tax debt. The benefit here is that you won't be charged a fee by the IRS like you would for a credit card and you may be eligible to borrow that money at a competitive rate. Still, in many cases, the interest you'll pay on a personal loan will exceed the interest you'll pay on an installment plan, so it certainly makes sense to explore the latter option before borrowing to cover your tax debt.
The IRS will cut you some slack
More than anything else, the IRS wants to collect its money. As such, it tends to give taxpayers a bit of leeway when they can't pay their tax bills right away. Therefore, before you rush to charge your tax bill on a credit card or take out a loan to cover it, see what an installment plan entails. At the same time, start padding your savings today so that if you wind up owing money on your taxes next year, you'll have an easy means of paying the IRS immediately.
More From The Motley Fool
- 10 Best Stocks to Buy Today
- The $16,728 Social Security Bonus You Cannot Afford to Miss
- 20 of the Top Stocks to Buy (Including the Two Every Investor Should Own)
- What Is an ETF?
- 5 Recession-Proof Stocks
- How to Beat the Market
The Motley Fool has a disclosure policy.