Borrowing from the IRS - Actual Cost

[JohnH]

We've had this conversation before, but I just recevied a notice from a client and thought I'd run the current numbers just for grins. I was curious about what the actual cost might be for someone who owes IRS, given the current interest rates.

Client originally filed an extension and then filed the return in August. They owed $8,192 and paid nothing when the return was filed. They received a bill today for $8,542, an amount which is good until Oct 3. The $350 difference is $122 FTP penalty plus $139 interest. FTP penalty is 1/2 of 1% per month, or the equivalent of a 6% APR. Interest is 4% APR.

Since the payment is due by Oct 3, this means they received 5-1/2 months of forebearance from Apr 15. Dividing the $350 by the $8,192, then dividing by 5.5 and multiplying by 12 yields a true interest rate of 9.32% APR, with no compounding. (I think that's why the 10% actually drops to 9.32%)

Under these circumstances, why would anyone pay taxes with a credit card? I would certianly never advise them to do that, although I often hear that suggestion made. If they did a refi on their home to get the money, the transaction costs would make it impractical. They might imporove their rate if they had any cash available on a HELOC, but then they would be limiting their available cash for a true emergency.

So it seems to me that a taxpayer who owes money and doesn't have readily available cash might might be wise to just set up a payment plan with the IRS, at least until interest rates start to trend upward.

[ChEAr$]

The interest may not be tax deductible (it isn't of course) but with those numbers, one is usually better off getting an installment agreement.
Unless of course, he has no debt and is making more than 4% on cd's (fat chance these days)

So, John, I concur.

[JohnH]

Yes, I ignored tax deductibility primarily because it isn't particularly relevant at these levels. Borrowing $8,500 at 6% on a HELOC, for example, would produce an interest deduction of $510, and using a combined Fed & state tax rate of 20% would mean the tax deduction only reduces their borrowing cost by $100 per year, for a net borrowing cost of $410 in year one.

Comparing the $760 they pay the IRS in the intial year against the $410 after-tax cost of the HELOC means they are paying $350 in the first year to borrow from IRS. The differential decreases each year as the principal balance is paid down.

Someone struggling to pay their taxes might make the rational decision that it's worth the extra $350 cost in order to keep that line of credit open and available for true emergencies.

I did ignore any opprtunity cost associated with giving up the earnings on a CD, since someone facing these types of diffculties probably doesn't have any extra cash sitting around earning interest.

[joanmcq]

And with what a CD is paying, it's irrelevant anyways!

[Snaggletooth]

Installment Plan

There is a difference between simply getting a bill and paying late versus setting up an installment plan.

Last time I looked into it, there would be yet another $92 fee attached to setting up an installment plan. And further interest, but not at any horrendous credit card rate.

And then paying by credit card, there is another 2% "convenience fee". In other words, govt is not going to pay the usual kickback to the credit card that a vendor would be required. By law, vendor is not permitted to pass the credit card commission onto the price of his product, but somehow this doesn't apply to the govt. Another example of govt not wanting to live with the laws they expect us to live with.

[DaveinTexas]

Credit Card

I agree that a credit card is not the wise move to pay your Federal Taxes. I just opened a Lowes card recently and they graciously extended me a credit line over $10K with an APR of just under 26%!!! Awesome! That should be illegal!

But, I have heard from some tax preparers that owing Visa, Mastercard or (insert credit card lending institution) is better than owing the IRS. This is especially true if the taxpayer plans on filing for bankruptcy and a Ch. 7 is in their future!!

Also, credit card lenders (typically) won't sue for judgement or seek a lien/levy for non-payment; they just chalk it up as a cancellation of debt. Not a bad strategy if your client is in a bad financial position, maybe his earnings are too high to qualify for OIC, but has some available credit. Try this card, no, ok, try this card, no, ok.....