10 worst ways to pay your tax bill

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The bumper sticker is true: The IRS does have what it takes to take what you’ve got. But don’t be in such a panic to pay the tax collector that you make an unwise payment decision.

Frantic taxpayers too often come up with imprudent ways to raise tax cash, especially when the April deadline is looming and the Internal Revenue Service bill is relatively small. But even a small amount can quickly balloon if exorbitant interest rates — or other strings — are attached.

Before you make a tax-payment mistake, check out these 10 worst ways to pay Uncle Sam.

10. Get a cash advance against your paycheck.
The Federal Trade Commission warns that the typical annual percentage rate of interest on payday loans is 391 percent. That means if you borrow $300 and fail to pay it back in two months’ worth of paydays, you’ll owe $495. Maybe a big spender like you can afford that. But most of us can’t.

9. Get a cash advance on your credit card.
Fees for cash advances vary, but most issuers charge you a 3 or 4 percent upfront fee (or a minimum of $20) plus an interest rate of between 20 percent and 25 percent. According to Bankrate’s minimum payment calculator, if you pay the least possible each month on a $300 advance at 20 percent interest, it will take you 42 months to be rid of your credit card debt. In that time, you will pay just over $119 in interest, plus the $20 that you paid upfront for a total of $439. And that, of course, presumes you don’t charge another cent to that card. If you have to resort to this and you’ve been a good credit card customer, you can try asking for a lower interest rate.

8. Pawn your diamond ring.
You’ll probably have trouble getting as much as $300 for anything short of the Hope diamond, but if you’re successful, expect to pay for the privilege. Hocking possessions to raise quick cash is such a time-honored business that virtually every state has similar and fairly tough regulations holding interest to 3 percent a month or 36 percent a year, plus a 20-percent upfront service charge. Twelve months is usually the maximum length of the loan. So if you borrow $300, pay the upfront fee and the carrying charges every month for a year, it’ll cost you $468 to get your ring back. If you don’t pay, kiss the ring goodbye.

7. Take out a personal loan.
The rates on unsecured personal loans can be ugly, but not as ugly as some other fast-cash options. If you happen to have a credit union available to you, try that first because the rate is usually at least 2 percentage points lower.

6. Charge your tax bill.
As the April deadline approaches, the pay-with-plastic option begins to look like the answer. But you’ll be charged a “convenience fee” of about 2.5 percent based on the amount charged. Don’t be confused by the word convenience. It isn’t for your convenience. It’s for the convenience of the credit card company because the IRS won’t cover the merchant fees. With an interest rate of 15 percent and minimum monthly payments, Bankrate’s calculator figures it will take you 38 months to discharge a $300 tax debt. Your total bill will come to a relatively modest total of about $378, as long as you don’t use the card again until the tax balance is paid.

5. Use your home equity.
If you have a home equity line of credit, it will allow you to borrow against it usually by just writing a check. Interest rates on equity accounts are attractive and if you pay what you owe quickly, this debt will cost less than putting the same amount on your credit card. But if interest rates head up, so will equity line rates. And by using this payment method, your home is the collateral for even the relatively small amount you used to pay your tax bill.

4. Gamble on the float.
It takes the government an average of five business days to actually cash your check, sometimes longer in mid-April when there are tractor-trailers full of forms in the parking lot of every IRS processing center. If you get paid the day after taxes are due, chances are the check you mailed April 15 won’t bounce. But be aware that you’re still taking a chance. If your check does bounce, the government considers it as nonpayment, meaning you can expect to cough up a 0.5 percent per month penalty. Plus, your bank is likely to charge you an insufficient funds fee.

3. Dig into your retirement account.
Many 401(k) and 403(b) employer-sponsored plans have provisions that allow you to borrow your own money and pay it back to yourself without penalty. The interest rate is usually low. You can’t borrow against your IRA, but you can withdraw the money and use it for 60 days without penalty as long as you redeposit it into the same or a new IRA account. If the money doesn’t find its way back into an IRA account within the 60-day period, it will be subject to taxes and penalties. You can only use this 60-day provision once a year. The clock starts ticking on the date you receive the distribution.

While it’s easy to temporarily withdraw some retirement money, most financial experts advise against it unless it’s an absolute last resort. Your retirement nest egg should be a safe haven rather than an emergency fund. Bankrate’s 401(k) loan calculator can help you figure the cost of raiding your retirement account.

2. Hit up the folks.

Borrowing from relatives has one big drawback: It can ruin a relationship. But if you only need the money for a short period and dad (or mom or sis) can afford it, ask. And make it formal. A note from you specifying the terms of repayment will make you feel less like a 12-year-old begging for your allowance. If dad says “no,” accept the turndown graciously and assume he has a good reason.

1. Pay off the government monthly.
For an initial $43 set-up charge, the IRS will let you pay on the installment plan if you file Form 9465, Installment Agreement Request . The current interest rate is 7 percent annually, but the IRS adjusts it quarterly so it will go up when the rest of the rates head that direction. And while the government payment plan will cut your late payment penalties in half (to one-quarter percent per month), on a $300 balance that saves you less than 50 cents a month. Plus, you have to give the IRS permission to attach your bank account if you fail to pay.

Eva Rosenberg, publisher of TaxMama.com, says if you decide to file your return without paying, but you’re confident you can pay what you owe before the end of the year, don’t file the installment agreement. That way you save the $43 upfront fee and don’t hand over your bank account information to the IRS. Instead, Rosenberg suggests you simply file your taxes and send the IRS as much as you can afford at that time. Then save up and send money every time the agency sends you a notice about your balance due.

Otherwise, put your tax return on an extension and buy yourself up to six months before IRS starts collections actions.

But be very careful. If you’re not disciplined enough to pay off Uncle Sam, without the paperwork, if year-end arrives and you find you owe 2005 taxes and you’ve still not paid off your 2004 bill, you’ll be in instant default. In this case, the penalties and interest are brutal.

And so that you don’t have to worry about coming up with tax cash next year, make sure your payroll withholding amount is correct now. Through this process, wage earners have a percentage of pay taken out each pay period and sent to the IRS where it is credited toward the taxpayer’s final tax bill. If you have too little taken out, you’ll owe money when you file your annual return.

You can adjust your withholding simply by filing a new W-4 with your payroll office. True, you’ll have to deal with a slight cut in take-home pay, but you won’t have to write a big check to Uncle Sam next April.

Jennie L. Phipps is a contributing editor based in Michigan.