Should I Use an IRS Payment Plan or Personal Loan to Pay My Taxes?

Owing money to the Internal Revenue Service (IRS) is never a good feeling, but it can be especially stressful when you don't have sufficient funds for repayment. Fortunately, you have some options, including taking out a personal loan or setting up a payment plan with the IRS.

How IRS Payment Plans Work

When you owe money to the IRS but aren't able to pay, you can't just hope the problem will go away on its own. The IRS imposes penalties on people who file their taxes but cannot pay their bill. (And it is even harsher on people who don't file at all.) As of 2023, the penalties for nonpayment and not setting up a payment plan are equal to 0.50% per month (up to a maximum of 25%) of amounts owed until the debt is satisfied.

The IRS offers payment plans if you can't afford the entire amount you owe upfront, in which case the penalty rate drops in half to 0.25%. That said, you'll still owe interest on the debt; the interest rate is currently 8%.

Individuals have two payment plan options to choose from: short-term payment plans and long-term ones. (Different rules apply to business taxpayers.)

With a short-term payment plan, you get an extra 180 days to pay the balance on your tax bill. To be eligible, you must owe less than $100,000 in total, including taxes, interest, and penalties.

Long-term payment plans, also called installment agreements, allow you to pay off your balance in monthly installments over a period as long as 72 months. To be eligible, your total balance (again including taxes, penalties, and interest) must be less than $50,000.

Taxpayers who owe more than $50,000 but less than $250,000 may also be eligible for what the IRS calls a non-streamlined installment agreement (NSIA).

How Personal Loans Work

If you don't want to get the IRS involved in your problem, you can take out a personal loan to pay your tax bill. This option is fairly common and relatively straightforward since most personal loans have fixed interest rates, fixed monthly payments, and a set repayment plan that does not change. Their terms can range from a few months to a number of years.

Personal loans are widely available from banks, credit unions, and other lenders. Most are unsecured, meaning that you don't have to put up any collateral to protect the lender in case you default. For that reason, you will need a credit score that is high enough to meet the lender's requirements.

IRS Payment Plan Pros and Cons

To take advantage of any of its repayment plans, you must apply to the IRS, which provides instructions online. Before you move forward, however, it's worth considering the pros and cons.

IRS Payment Plan Pros

• You could pay less in interest and fees: With IRS payment plan interest rates at 8% and the lower penalty rate of 0.25% per month, it's possible that you'll have lower ongoing costs by repaying this way than if you borrowed the money with a personal loan.
• Payment plans can last for up to 72 months: Having up to 72 months to pay your tax bill can help you establish a monthly payment you can afford.
• You'll avoid borrowing money: When you set up a payment plan with the IRS, you avoid taking out more loans that could create a cycle of debt and financial stress that lasts for years.

IRS Payment Plan Cons

• Plan limits apply: Most long-term payment plans from the IRS are only available to individuals who owe less than $50,000, including taxes, penalties, and interest. (NSIAs are an exception.)
• Plans can charge setup fees: Long-term payment plans require setup fees of $31 to $225, depending on whether you set up automatic payments and whether you apply for the plan online, over the phone, or in person. Reduced setup fees are also available for taxpayers with a low income.
• The process can be cumbersome: Anytime you deal with a government agency, you may encounter long wait times on the phone and other issues along the way.

Personal Loan Pros and Cons

If you prefer, you can skip dealing with the IRS altogether and instead take out a personal loan to pay off your debt. In that case, you would have the loan funds deposited into your bank account, then set up a transfer to the IRS to pay your tax bill.

Before you choose a personal loan to pay your taxes, consider the following:

Personal Loan Pros

• Apply and get funding online: A personal loan application process can often be completed in less than 10 minutes, and if approved, you'll typically receive funding within a few business days.
• Choose a personal loan with the terms you want: You'll have the chance to shop around for a personal loan that has an interest rate, repayment term, and monthly payment that suits your needs.
• Avoid the hassle of dealing with the IRS: Not having to deal with the IRS definitely has its benefits, and a personal loan lets you sidestep this situation.

Personal Loan Cons

• You might not qualify: You'll generally need a credit score in at least the "good" range to get a personal loan with a decent interest rate. In terms of FICO scores, that means a score no lower than 670. If you have a poor score you may not be eligible for one at all.
• Your loan costs could be higher: Even if you have good credit, your total loan costs with a personal loan could be higher than what you would pay under an IRS payment plan. Not only could your interest rate be higher, but many personal loans also charge origination fees.
• You could see an impact on your credit: Taking out a loan could affect your debt-to-income (DTI) ratio, or the amount of monthly payments you owe in relation to your gross monthly income. This could make it more difficult to obtain other credit if you need to.
• You're borrowing more money: Taking out a loan has its risks, including the possibility that you'll be unable to pay it back.

Other Ways to Pay

If you're on the fence between using an IRS payment plan or a personal loan to pay your taxes, there are a few alternatives to consider.

For example, the IRS makes it possible to pay your tax bill with a credit card in exchange for an upfront fee of 1.85% to 1.98%, depending on the platform you use. However, given the interest rates on most credit cards, putting your tax debt on a credit card can become very costly very quickly.

You might also be able to negotiate with the IRS to settle the debt for less than the full amount you owe through what's called an offer in compromise.

Finally, you could also consider taking out a 401(k) loan if you have a 401(k) plan at work and your employer allows it. This type of loan lets you borrow from your retirement savings and make payments (including interest) back into the account. However, you have to repay your 401(k) loan in full within five years in most cases, and you may have to pay it back immediately if you leave your job.

The Bottom Line

If you owe money to the IRS, you should try to deal with that debt as soon as possible. This may mean applying for an IRS payment plan to pay it off over time or borrowing money with a personal loan to pay it off all at once. You can also consider alternatives, such as borrowing money from your 401(k) plan. Any of these options will cost you money, but they can help you avoid mounting interest and fees that add even more to your tax bill—not to mention keeping you out of legal trouble.