Should I Borrow to Pay Tax?

Small to mid-sized businesses must constantly manage cash flow. For most, this usually means they also must consider and manage debt. A common concern is accumulating tax debt.

Simple question, then. If you owe tax, does it make sense to take a loan, and pay off the tax liability? Or is it better to seek some form of tax resolution? There is no simple answer, because every situation is different. But one thing is certain:

There is more to consider than just comparing interest rates!

Tax collection enforcement is the main catalyst which drives the act of tax resolution and payment. Tax levies, tax liens, and threats to seize assets motivate action. The embarrassing discovery, the stressful confusion imposed, or the urgent threat of collection enforcement are emotional factors that you must consider as you also contrast whether to apply for a loan, or to seek a more structured tax resolution.

Simply put, IRS tax collection enforcement creates emergency. If you owe significant amounts of tax, you need a solution that will quickly stop enforcement, retain credit, preserve working capital, balance cash flow, and eliminate the liability.

Now here’s more. When you seek answers, or ask for help, both sides are in competition. Tax lawyers want to sell IRS tax resolution services. Short-term lenders aim to sell you the convenience of a loan. Either side has its own benefits and carries its own burdens, not all financial. Both sides make great arguments.

Key Points You Need to Know

Let’s start with what options are available.  The IRS tax resolution industry bombards us all with so many options. (Yes, even attorneys like me, currently working in the field of IRS tax representation.) So let’s just make a quick, highlighted summary of available options to handle tax debt.

Short-Term Borrowing. One of the most obvious options is to take a short-term loan. This is especially attractive if the liability can be paid in 120 days. In such a case, IRS has been known to delay collection enforcement for that duration, while you set up the loan.

IRS tax debt is penalized monthly. The statutory “late-payment” penalty is generally 0.5% of your unpaid taxes per month, and can accrue a great many months. Combined penalties can add up to 5% per month to the liability. Paying tax debt via credit or third-party loan may be less expensive than accruing these penalties.

• Note: The earlier the tax is paid, the greater avoidance of the penalty. While you are still deciding, that late-payment penalty continues to accrue, and becomes part of the tax debt.

Getting a loan and paying the tax will make IRS collection enforcement go away. That is a win.

HOWEVER, short-term borrowing assumes that a loan is available. The borrower will need a qualifying credit score, being a “bare-minimum” 620 FICO? score, but likely much higher. Some lenders may want to secure the loan with business receivables, or other liquefiable asset. We all know that you’ll only qualify for the lowest rates if you have excellent credit. Those with the strongest credit rating can shop around for the best rate!

If neither the minimum credit score nor possible collateral are not there, the borrowing option narrows.

Usually, lenders will first require a hard pull on your credit. We all know that repeated credit inquiries tend to reduce a person’s overall credit score. That credit inquiry for a short-term loan could create its own burden. This is because a person facing tax trouble may typically have other financial woes, needing access to additional credit. For example, there may be a vehicle or equipment that needs replacing. Or maybe the business needs access to a cash line of credit, in order to fund the next month of payroll expenses. That additional ding on a business owner’s credit could have a lasting, negative effect.

•  One note: If you are under a tax lien (federal or state), borrowing to fully pay the tax will “Release” you from the tax lien. However, having a tax lien is often the very same item of negative credit history that prevents you from qualifying for a loan. It’s sort of like a dog chasing its tail.

I like my clients to also think about the payment terms. Lenders tend to arrange payment terms that optimize their profit with their risk. That said, the repayment period usually ranges between 24-60 months. That might seem reasonable – having 2 to 5-year payback period. But if the payments for such a loan are not realistic, then neither is this option.

• You might consider an IRS Installment Agreement (or “IA”), which is based upon your ability to pay. The “IA” could be for repaying the full amount of tax, over as long as 7-10 years. That’s a longer payment period, for sure. But the payments are intended to be realistic. It should be said that a skilled tax representation attorney can help make the payments more realistic.

IRS Installment Agreements. Sometimes it is more advantageous to pay IRS slowly, over time. This option is available in several different forms. There is plenty of advertising talking about IRS’s new, “Fresh Start Initiative”. (Actually, it is just called “Fresh Start”, and has been around since 2011.) Other variations include Direct Debit or manual payment options. Then there are partial payment plans which, true to their name, mean you will not pay the full liability. A variation of the partial payment plan is the “Currently-Not-Collectible” status. Parallel to the name, IRS could decide that now is not the best time to collect your back tax payments. And maybe they will try later.

For most IRS payment alternatives, a detailed, comprehensive disclosure of your financial position is required. Depending on the amount of liability, the age of the liability, your IRS history and other factors, IRS will want to review a full presentation of your financial profile. This process presents gives IRS opportunity a full view of your net income, and net assets.

• Note: Only the most skilled tax defense attorneys can turn this required financial disclosure as an advantage. For larger debt cases, you want the IRS tax resolution attorney to apply a knowledge of various elements of property law, elder law, family law, bankruptcy law, finance and transactional law, and of course, tax law.

The IRS-IA is much like financing a loan. You should certainly consider and compare the cost of interest between having a bank, or having IRS “carry” the debt. Interest rates on outstanding taxes are essentially the same for everyone in tax debt, and is usually a lower rate than for most personal loans. Earlier we mentioned that short-term loans could sometime charge interest cost ranging from 6% to nearly 36% of the principal. In contrast, during 2019, IRS interest ranged from 5% to 6%.

IRS has no loan origination fee. But there is a setup fee to establish the agreement. Compared to a 1% to 5% amount of loan origination fee, however, IRS’s initial setup fee ranges only between $31 to $225.

This set of options is also not always available either, however. To establish an IA, you must be “compliant”. In other words, all past tax returns must be filed. All new returns must be timely filed and paid. And all payments must be made, on schedule. For many business owners, this is harder than it sounds.

• Many business owners in tax trouble are years behind in filing tax returns. It may take weeks to locate the necessary business records, and even months to compile an accurate set of tax returns. If you are under IRS collection enforcement (such as a bank levy), you may require faster resolution. In that case, taking a loan may be more attractive.

The term of years for repayment is a definite plus over borrowing. IRS can allow up to 7 to 10 years to repay a liability. As with loans, interest continues to accrue and add to the cost. During the period of repayment, the penalties will cease to accrue. So that factor is also a plus.

Tax Settlements (Offer-in-Compromises, and Other Applications of the Law). When IRS finances your tax debt, or if you apply other areas of law, you have greater leverage to have the taxes reduced. As you weigh tax resolution against borrowing, remember that the best option may be a settlement of the tax.

• Sometimes in these cases, settlement could include both resolution services and borrowed funds.

For example, IRS tax liability has a 10-year “Collection Statute Expiration Date”. This 10-year period is the debt’s “life-span”, during which the IRS can lawfully collect tax debt. After that period expires, the debt is written off, and just goes away. There are some exceptions, for sure. But you should be aware of this general rule. As you might imagine, as the debt reaches that expiration date, IRS is more motivated to cooperate, even negotiate collection of the tax. Again, a tax settlement solution may involve resolution services and some borrowed funds.

Another example is the power of U.S. Bankruptcy. As a background, know that filing a bankruptcy petition immediately ceases nearly all tax collection enforcement. But also, taxes based on income (like income taxes and self-employment taxes) could be fully dischargeable in bankruptcy. If argued, IRS must evaluate the likely amount of tax it can collect. On the other hand, IRS may find that a payment arrangement, a lump sum payment, or some combination that favors the business owner, could be better than losing the total amount of tax debt through bankruptcy.

• For business owners with large liabilities, the most effective attorney applies legal concerns covering multiple areas of law (such as property law, the statute date, or bankruptcy law). This skill is applied most commonly with the Offer-in-Compromise. More below.

The IRS Offer-in-Compromise (“OIC”) is the settlement program that we most commonly hear about over broadcast media. In a nutshell, the OIC allows someone owing tax to make an offer to IRS, as a way to settle (to “comprise”) the total amount of tax. Sometimes this option is available. Sometimes it is an advantageous option, as compared to a loan or an installment agreement. But the OIC is not always helpful, or even available to every person.

Typically, IRS will evaluate the Offer-in-Compromise based upon that person’s financial position, at the time of the offer. However, the same offer will also be evaluated on that person’s financial position 9 to 12 months after the offer. IRS may use the contrasted financial positions to negotiate and make a counteroffer.

• When that person, maybe a business owner, has a more profitable year, the IRS counteroffer may be unrealistic, or unattractive. And in that case, another resolution and/or use of borrowed funds may be the better choice.

Most offers require scheduled, substantial payments, per the offer submitted. And many require a 20% “down payment” of the amount offered. IRS may eventually reject the offer. The applicant may reject IRS’s counter-offer. In either case, IRS keeps the 20% payment.

Some of the installment agreement rules apply, as well. All tax returns must be filed. Payments must be made as scheduled. There is a $186 application fee.

Remember, in resolving IRS tax debt, there are several options. There are many variations of those options. And multiple factors help determine which options are best, or at least most available. When you seek help, just remember, you want your solution to quickly stop enforcement, retain credit, preserve assets and working capital, balance cash flow, and eliminate the liability.

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