How to Eliminate Tax Debt

Now that the dust has settled, tax day behind us, do you owe the IRS more than you have available to send them? Let’s look at the ways you might consider, starting with the easiest.

Ask for additional time to pay: It’s nearly that easy. You can request an additional 60 to 120 days to pay what you owe. You can call the IRS or go to the Online Payment Agreement and submit your information. This is a good solution if you have a first quarter bonus coming in or just needed time to rearrange some of your assets to free up the cash.

Apply for the Installment Plan: You can use this option to pay off a tax debt of up to $25,000 over as long as 60 months. You can use the same Online Payment Agreement link or apply by using Form 9465. Your application is subject to approval but it’s guaranteed if the amount owed is not over $10,000, you have a clean record for the prior five years (all taxes paid with or prior to the return due date), you agree to pay it in full within three years, and the IRS determines you can’t pay in full immediately.

Pay by credit card or debit card: Since the penalty can be as much as 1/2%/mo and interest is currently 4% annually, you may have a credit card that offers a lower rate, perhaps even a zero percent teaser rate for a year. With average credit card rates still at 14% in addition to the 2%+ fee from the card service provider, the IRS route still seems best in most cases. The fee to pay with a debit card is less than $4, but if you have the cash to debit, why not just cut the check?

401(k) loan: The rules for these loans allow you to borrow up to 50% of your vested balance for five years. The current rate (based on the common “Prime+1/2%) is about 3.75%. There are risks, however. Should you lose your job, your loan balance is subtracted from your account and the amount is deemed as distributed. Taxes and 10% penalty are then due which results in yet another debt to the IRS.

The IRA shuffle: You can’t borrow from your IRA, but did you know that if you wish to transfer the funds from one account to another, you have 60 days to do this? In effect, this is the same as a 60 day loan. So long as the money is deposited into a different account on or before day day 60, there’s no tax or penalty. You should only consider this option if you are certain of having the money within the 60 days, otherwise, there’s a high price to pay, both tax and a 10% penalty.

HELOC: The home equity line of credit is to be used as a last resort, it puts your house at risk if you default. With most HELOCs tied to the Prime Rate plus a bit of an adder the rate will be in the 4%-5% range. Not a bad cost to borrow and you avoid any penalty. If you choose this type of loan, try to pay it off quickly, the bill’s minimum payment will likely reflect interest only. Don’t let a single year’s tax bill turn into 10 years of payments.

Now that you’ve decided how to pay the tax man, take a look at How to Adjust Your Tax Withholding for the New Year. Understanding and making changes to your withholding this year will prevent you from owing so much in April 2012.

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