Pay off your tax debt with a home equity line of credit (HELOC)
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Pay off your tax debt with a home equity line of credit (HELOC)

Pay off your tax debt with a home equity line of credit (HELOC)

Is it a good idea to use a HELOC to pay taxes?

Tax season for the fiscal year 2022 is among us, and while some look forward to getting cash back from Uncle Sam, others of us get the dreaded news: we owe the IRS, perhaps more than we planned for.

Whether the news came from your accountant or online tax software, it is normal to feel overwhelmed. Receiving a large, unexpected bill never feels good. If you find yourself in a situation where you owe more than you are able to pay, there are plenty of options for how to pay, even if you fee in over your head.

These range from IRS installment plans, credit cards, personal loans, and tapping into your home equity in the form of a home equity loan or home equity line of credit (HELOC). Read on to learn about the pros and cons of all available options in order to make the best choice for yourself and family. 

Ways to pay taxes to the IRS

If you owe money to the IRS, ways to pay include:

  1. Payment in full via the IRS webpage. Payment options include cash, check, wire transfer, money order, or e-payment through your accountant or tax software. This avoids paying any penalties, interest, or fees, and is therefore the lowest-cost option. However, this is choice is not always available if you don’t have cash on hand.

  2. A HELOC or other low-interest loan. The IRS recommends low-interest loans or lines of credit as a more economic way to pay for tax debt over time, due to lower interest rates, penalties, and fees.

  3. Apply for an IRS installment plan. Short-term (under 180 days) or long-term (over 180 days) payment plans are available. This will include a monthly penalty and compound daily at 7% interest.

  4. Credit card. A credit card should be a last resort, as most credit cards come with a high-interest rate, making the total amount paid over time higher than if using other financing options.

IRS installment plans and alternative tax payment financing

If you have the funds to cover your tax debt, you are able to use your bank account, electronic funds withdrawal from your tax software, debit card, wire transfer, cash, check, or digital wallet app to make payment in full. 

When paying the full tax amount isn't an option, the IRS allows you to apply for an IRS short-term installment plan ( less than 180 days), an IRS long-term installment plan (more than 180 days), or, as many people do, turn to a credit card.

IRS payment plans do not come cost-free. Late penalties are applied to your total debt and interest compounds daily on the balance until it is paid off. Credit cards also usually have steep interest rates, making them a poor choice for paying off tax debt unless you plan to pay down the balance quickly. 

The Internal Revenue Service (IRS) recommends that taxpayers explore private loan options before exploring payment plans, due to the penalties and interest associated with the installment plans they offer. According to the IRS:

In many cases, loan costs may be lower than the combination of interest and penalties the IRS must charge under federal law. Normally, the late-payment penalty is 0.5% per month, not to exceed 25% of unpaid taxes... If a taxpayer can't get a loan, the IRS offers other options.

The current IRS interest rate is 7% daily, compounding daily, on top of the .5% monthly penalty. According to Lending Tree, the average credit card interest rate in the US today is 23.55%.

In comparison, if you have built equity in your home, you may be eligible for a home equity line of credit (HELOC), which usually carries an interest rate between 5-8%. This is considerably lower than a credit card or the daily compounding interest on an IRS installment plan. Using a HELOC to pay your taxes can reduce the total amount you pay over time.

Using a HELOC to pay for this year's taxes

If you need to borrow money to pay off your taxes and have built up equity in your home, a HELOC may be the best option to consider. Installment plans offered by the IRS, credit cards, and personal loans, can all come with high-interest rates that lead to a higher overall cost than a HELOC. 

A Home Equity Line of Credit (HELOC) is a form of borrowing that enables homeowners to tap into the equity they've built up in their home and use it as collateral on a line of credit. The main benefits associated with opening up a HELOC is the access to large amounts of capital, lower interest rates than other borrowing options, quick and easy approval, and flexible payment plans. 

Applying for a HELOC is quick and easy, usually taking around 3-5 weeks. Homeowners are often approved for 80% of the value of their home equity. Equity is calculated from a current appraisal, deducting the amount you owe on existing mortgage(s) from the value of your property. 

HELOC interest payment tax deductions

Traditional, home equity loan and home equity line (HELOC) interest was tax deductible, making it a great way to access cash while lowering your annual tax bill. However, in 2017 Congress passed the 2017 Tax Cuts and Jobs Act (TCJA), which significantly limited tax deductions. Now, you can deduct interest costs on home equity debt only when you use the funds to "buy, build, or make substantial home improvements." Furthermore, interest payments can only be deducted on the first $750,000 of the HELOC (if filing married, jointly), or the first $375,000 (if filing as an individual).  

Key Takeaways:

  • You are not alone if you find yourself with a large outstanding tax debt this year. While it can be overwhelming, there are many options available to you to pay off your debt.

  • A HELOC (home equity line of credit) is also a great alternative to credit cards and IRS installment payment plans to pay off tax debt, due to lower fees and interest rates.

  • A HELOC (home equity line of credit) is one tool to bring down your tax debt if it was acquired during or before the tax year you owe, AND it was used to "buy, build, or make substantial home improvements."

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