Finding the Cash for a Tax Bill

An extension to file is not an extension to pay. The balance is due on the original filing deadline whatever paperwork you have pending, and from that date the meter runs: interest under IRC §6621, “Determination of rate of interest” at the federal short-term rate plus three percentage points, compounded daily, plus the 0.5% monthly failure-to-pay charge. That combination is the hurdle rate every option below has to beat. It is a knowable number, not a scary one — compute it before you decide where the money comes from, because half the panic decisions in this situation are made by people who assumed the IRS charges credit-card rates.

Do two things before you go looking. Fix the withholding that produced the gap, so next April is not a repeat (section “Safe Harbor”, and section “The RSU and Bonus Tax Gap” if the culprit was equity compensation). And file on time regardless of what you can pay — the failure-to-file penalty runs at nine times the failure-to-pay penalty.

Then work down the list, cheapest capital first:

Redirect the cash flow you already have

Suspend automatic investment purchases and optional payroll deductions, and postpone discretionary spending until the bill clears. One exception: do not cut 401(k) contributions below the level that captures the full employer match. An instant 50–100% return is the most expensive thing in this chapter to give up, and the shortfall it closes is small.

Bank cash, maturing T-bills, and CDs

The obvious source. Weigh a CD’s early-withdrawal penalty — typically a few months of interest — against the daily-compounding IRS rate; the CD usually loses.

The emergency fund

A tax bill you cannot otherwise cover is an emergency, and this is what the fund is for (section “Sizing the Fund”). Draw it down deliberately and refill it on a schedule (section “Combining Sleeves and Refilling Discipline”) rather than treating the depletion as permanent.

Taxable assets, chosen for tax efficiency

Sell the highest-basis lots, pair sales with loss harvesting (section “Tax-loss harvesting”), and avoid realizing short-term gains taxed as ordinary income. Selling to pay tax generates tax; a careless liquidation funds this year’s bill by creating next year’s.

Secured borrowing

A HELOC (section “Home Equity Line of Credit”) or a securities-backed line (section “Asset Backed Loans (ABL)”) can beat liquidating a large embedded gain — borrowing at a spread over a benchmark is frequently cheaper than handing over 23.8% plus state tax to raise the same cash. Two conditions: the collateral must survive a drawdown without triggering a call, and you must price the loan correctly, because interest on money borrowed to pay personal income tax is nondeductible personal interest under IRC §163(h), “Interest” even when the tax arose from a business.

Credit card

The authorized processors charge a fee just under 2% of the payment. That is cheap for a few weeks of float and ruinous as term debt — worth it only against a genuine 0% promotional window you will clear, or to reach a sign-up bonus worth more than the fee.

401(k) loan

Ahead of any distribution, never in place of the rungs above (section “Borrowing from Your 401(k)”). The balance typically comes due when you leave the employer, which converts a job change into a taxable distribution at the worst possible moment.

What does not belong on the list at any rung: a hardship withdrawal or an IRA distribution to pay the bill. You would create a new taxable event, plus a 10% penalty before 59½, in order to settle an old one — and because the distribution is itself taxable, you must gross it up and withdraw substantially more than you owe. You permanently destroy tax-advantaged space that cannot be repurchased at any price, and you convert creditor-protected assets into cash (section “Asset Protection”). The IRS is a patient, statutorily rate-capped creditor. Your retirement account is not a checking account with a penalty attached.

If the whole list still comes up short, stop optimizing and go to the next section. And note the order this implies for a household with a balance sheet: an installment agreement, whose failure-to-pay charge halves to 0.25% a month while the agreement is in effect for a timely filer, is often simply the cheapest financing available — cheaper than realizing a large capital gain to avoid it. Paying the IRS over time is a pricing decision, not a confession.