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7 Unconventional Methods to Fund the Down Payment for an IRS Tax Payment Plan  Thumbnail

7 Unconventional Methods to Fund the Down Payment for an IRS Tax Payment Plan

Estate Planning Tax Planning

Many people who owe back taxes to the IRS are able to negotiate a tax payment plan, by which they pay their back taxes over time.  While this might incur additional cost in terms of interest and penalties, it is an option for people who might not be able to come up with all the money at once.   

The odds are, if you’ve accumulated six figures of tax debt, you probably have the earning power to pay off the money owed over a six year period (which the IRS generally can accept, if your balance is right).  If needed, the IRS will help you determine how much of your income should be allocated to living expenses, and how much can be set aside to pay down tax debt.  But the IRS’ method of helping you determine the right payment plan probably will come as an abrupt disruption to your lifestyle. 

To mitigate this disruption, you might be better off taking matters into your own hands.  If cash flow is an issue, you probably still need to curb unnecessary spending and be ready to set aside a significant amount of income to pay taxes (and to make sure you don’t fall behind this year’s taxes). 

However, your ability to negotiate an online payment plan depends partly on your balance.  The IRS only allows online payment plan submissions if your balance is less than $100,000 ($50,000 if you plan to pay your balance in full in less than 120 days).  If you owe more than six figures of tax debt, then you might need to submit a down payment just to get your outstanding balance to a point where your plan is accepted.   For many people, coming up with the cash for such a down payment can be a significant challenge.   

Generally speaking, people usually don’t have significant amounts of cash AND tax debt.  Assuming a huge bonus or other money event isn’t around the corner, you might need to turn to unconventional sources of money for that down payment.  While each of these options might be available, it’s important to note the various pitfalls, and what you need to consider to mitigate those pitfalls.   

These options generally fall into one of two categories:  loans from other people, or taking money from personal accounts that you wouldn’t normally touch.  I’ve ranked these in order of desirability (from my perspective).  However, since each situation is unique, I will point out ways in which another source of cash might be more preferable.  The caveat here is twofold: 

  • For loans:  you still have to pay them back.  If you cannot take a loan with a realistic expectation of paying it back, then don’t do it.  In that case, ask the IRS for help, and embrace the suck that comes with tightening your belt and filling out the Form 433-F, Collection Information Statement.   

  • For taking money from your non-liquid accounts:  You’re taking from your future self to pay your current liabilities.  For those of you with money in investments or retirement accounts:  While you can do this, you should still take steps to mitigate the impact.  Understand that there may be tax implications (that you need to address, lest you compound the problem).  Also, there might be some cases in which you can’t undo the damage (like putting money back into an IRA after you’ve already taken it out).   

Method 1:  Loans from friends and family 

Depending on your situation, this could be an easy or difficult conversation.  Or not even really an option at all.  But if it is an option, you should at least treat this loan as an arms-length transaction. 

In other words, if you’re going to borrow money from Mom and Dad, or rich uncle Phil, then you should do this with the intention of paying them back.  If not, then stop reading this article, and just ask them for what it is:  a gift. 

If you need help setting up an intra-family loan, there are a variety of ways to do it.  For a small annual fee, sites like ZimpleMoney will help families set up their own loans and help them administer the billing & collection of those loans. 

Method 2:  Home equity loan   

There are a couple of requirements for this to be a viable option.  First, you must have a home.  Second, you must have enough equity in your home that you can borrow from.  Generally speaking, banks require a loan-to-value (LTV) ratio of 80/20 in order to qualify.   

For example, if you have a $500,000 house, your combined mortgage and home equity loan cannot exceed $400,000.  If you already have a $300,000 mortgage, the most you could borrow would be $100,000.  If you had a $400,000 mortgage, you probably would not be able to get a home equity loan.  There are some lenders who might do what’s called a 90/10 loan (combined loans of up to 90% of the home’s value), but you might have to search around.   

Expect to pay a higher interest rate than your primary mortgage, but this is a doable option.  You could also do a cash-out refinance, which essentially the same thing, but with one loan instead of two.  Check with your current lender for details. 

Method 3:  Home equity line of credit 

Like a home equity loan, a home equity line of credit (also known as a HELOC), allows you to tap into your home’s equity to make your down payment.  The primary difference is that a home equity loan is a fixed payment, while HELOCs are considered revolving debt (like credit cards, where you pay as much or as little as you want each month, subject to a minimum payment).   

I ranked this lower than the home equity loan because revolving debt can be a slippery slope, particularly if you have had previous troubles getting your arms around cash flow.  Expect a higher interest rate than the home equity loan, due to the flexibility in making your payments. 

You can read more about how one of my clients paid off $140,000 in tax debt using this option (using a 90/10 loan as the down payment). 

Tax caveat:  Home equity loans used to be tax deductible under Schedule A.  Under the Tax Cuts and Jobs Act, home equity loans (of any kind) are only deductible if they were used to buy, build, or substantially improve your home.  Upgrading your kitchen would count—paying off back taxes does not, even if you used a cash-out refinance. 

Method 4:  Personal loans 

If you don’t have a home, or enough home equity, you can take out a personal loan (also known as a signature loan).  Since there is no collateral, expect to pay a higher interest rate than on a loan secured by a house.  Not all banks offer personal loans, but many do. 

Method 5:  Microlending websites 

Microlending is a relatively new trend, in which people can borrow money that is pooled together from normal people.  Much in the same way banks will offer personal loans, microlending websites, like Prosper and Lending Club will offer uncollateralized loans to people for a variety of reasons.   

You’ve got three parties at work: 

  • Borrower:  The borrower applies for a loan, to be paid off over a 3 or 5 year period.  They ask for a fixed amount of money (up to $40,000, usually).  As part of their application process, the borrower will fill out financial information and a personal statement about what they intend to use the loan for (like paying taxes). 

  • Microlending website:  Accepts borrower’s application, and posts it on their website for lenders (normal people with accounts who are looking to fund loans and make money) to fund.  If there are enough interested lenders, the loan is funded.   

  • Lenders:  People who fund loans through the microlending website.  Lenders can lend in increments as little as $25.  A person with $5,000 deposit can partially lend to as many as 200 people, which diversifies and lowers the risk. 

Microlending could be a viable option, if the others don’t pan out.  However, be prepared to pay significantly higher interest rates.  As of this posting, Prosper’s website cites interest rates of between 6.95% and 35.99%.  Lending Club has similar rates. 

Note:  I have not, nor will I ever, recommend credit cards as a viable option.  First, if you’re at the point where you’re paying 35.99% interest on a loan, you probably need to back up and really determine if you aren’t just better off working with the IRS directly.  Microlending website loans, regardless of their interest rates, are fixed payment loans.  And there are no pre-payment penalties, so if cash flow isn’t a long-term issue, this might be a viable short-term option.  Credit cards, however, are a different animal. 

Method 6:  Cashing out after-tax investments 

Now we’re starting to move away from third-party financing, and towards self-financing.  If you don’t have any personal investments (or retirement plans), then you might want to stop reading here. 

Cashing out after-tax investments encompasses a wide variety of investments that are not in a retirement account.  This might include CDs, stocks, bonds, mutual funds, or a combination—not in an IRA or workplace retirement plan (like 401k or 403b). 

There are a couple of considerations here: 

  • Taxes.  You wouldn’t be reading this article if taxes weren’t a clear and present danger in your current financial life.  Make sure you don’t compound the problem by selling investments without knowing the tax impact. 

  • Liquidity.  Some things, like selling stocks and mutual funds, are easily sold or redeemed.  This means they are relatively liquid assets—as in, you can liquidate them.  Some, like CDs, aren’t so liquid—a CD becomes 100% liquid on the day that it matures, but there are usually penalties for early redemption.  Keep in mind that the less liquid an asset is, the less money you’re going to get for them.   

  • Portfolio impact.  Let’s imagine you have a balanced portfolio (which could be a debate in of itself).  If you could sell a certain amount of each one of your holdings in equal proportions, you could keep your portfolio balanced (minus the money you need), and everything would be great.  Most likely, you probably won’t be able to do that, for a variety of reasons.  So you should keep in mind the impact that selling something would have on your portfolio. 

There are many more things to consider when selling securities to generate cash for your taxes.  However, if you need to go into more depth, you’re probably better off hiring a fee-only financial planner (or at least a tax professional, if taxes are your only concern) so you can go through your options. 

Method 7:  401(k) loan 

The next three options have some trade-offs.  A 401k loan is definitely not something I would advise lightly.  Neither is a premature IRA withdrawal.  For that matter, neither is racking up a bunch of tax debt.  So in the context of lesser of multiple evils, I would rank a 401k loan at the top, with a few caveats: 

  • Not all 401k plans have loan provisions.   

  • If you follow the 401k loan rules, you can repay the loan without it becoming a taxable event.  Check with your plan administrator, and make sure you know the 401k loan rules cold.  The IRS restrictions include: 

  • Maximum of 50% of the vested account balance or $50,000, whichever is less 

  • Repayment over a 5 year schedule (unless you’re buying a house, which you’re not) 

  • Substantially level payments, at least quarterly, over the life of the loan (although prepayments are allowed). 

The key here is to make sure you can take a 401k loan without making it a taxable event.  If you run afoul of the payment plan rules, then you’ll be subject to taxes and possible penalties—which don’t help you in this situation.   

Creditor protection note:  A bankruptcy attorney might suggest keeping your assets in an employer-sponsored plan, protected under the Employee Retirement Income Security Act of 1974 (ERISA), vice your IRAs.  ERISA plans do generally provide greater protection against creditors than do IRAs.  I ranked 401(k)s as the lesser of those evils simply because of the loan provisions and because you can put much more money into your 401k once you get yourself out of this pickle.  However, if creditor protection or bankruptcy are possible issues, then disregard everything you’ve read in this article and find a good bankruptcy attorney in your state.    

Method 8:  Roth IRA distributions 

To Roth, or not to Roth?  That is the question.   

First of all, this assumes you have a Roth IRA AND a traditional IRA.  If you have both, there are arguments to be made either way.  However, it’s important to note that unlike a 401k, once you take money out of your IRA, you can’t put it back.  Think about it.  A 40-year old taking $50,000 out of your IRA today would take 8+ years to ‘pay back’ their distribution (at 2019’s contribution limits of $6,000 per year).  And that doesn’t account for the lost earnings over that time, either.  This is not a decision to be taken lightly. 

Taking money from your Roth IRA does jeopardize your projected tax-free income of your current investments.  However, if you’re in dire straits, you might consider a Roth over a traditional IRA simply because you might avoid paying taxes on qualified distributions.  You might even avoid paying taxes on taking out the after-tax money you contributed into your Roth, if you meet certain criteria. 

Since this isn’t a tutorial on the taxation of Roth IRA distributions, you might want to talk with your tax professional or financial advisor on whether this is a viable option for you. 

Method 9:  IRA distributions 

Last, in my mind, would be the IRA withdrawal.  This is simply because our focus is on paying off your tax debt—this focus should at least address the issue of whether the solutions compound the debt even further.   

Keep in mind that withdrawing from your IRA will cause a taxable event, even if it’s a qualified distribution.  This is true even if you’re 59 ½ or older, or meet any of the other IRS criteria for qualified withdrawals.  The only thing that a qualified withdrawal will help you avoid is the 10% additional tax for an early distribution. 

If you do take an IRA distribution, then you should ensure that you: 

  • Take enough to cover the money you need AND estimated taxes for the distribution 

  • Pay estimated taxes on the distribution as you take it. 

A previous client compounded their tax problem by not withholding enough from their IRA distribution for the current year’s taxes.  While they were able to pay some of the back taxes, they had a HUGE tax bill the following year.  Don’t let this happen to you. 


If you made it to the bottom of this article, congratulations.  While we covered 9 non-ideal ways to come up with money for a tax payment plan, it’s worth noting that these are also assumed to be short-term fixes for people with adequate cash flow, and who have a long-term solution in mind—and the willingness to avoid repeating the mistakes that caused this problem in the first place.   

If you have cash flow (or at least you know you have the income), but are still having trouble, perhaps the right financial planner can help you put it all together.  In that case, let us know.  We’d love to see if we can help. 

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