When tax season rolls around, it can create a ton of anxiety if you owe money to the IRS. And if your tax bill is more than you can afford to pay, then anxiety turns into paralyzing fear in a big hurry. If you're having problems scrounging up the money to pay the IRS, does it make sense to pay your taxes with a credit card?
Well, you certainly have the option to use a credit card as long as you have enough available credit to cover the expense. But should you pay your taxes with a credit card? That's really the best way to ask that question. So let's take a look at a few things you should think about before whipping out your plastic.
You Can Earn Rewards If You Pay with a Credit Card
Paying your taxes with a credit card and earning miles or cash back sounds like a great idea, doesn't it? But there is a convenience fee that you have to pay. For credit cards, the fee ranges from 1.87 percent to about 2.35 percent of the amount owed. So let's run the numbers and see what we've got.
Let's say your tax bill is $3,000 and you have an airline miles card that offers 2 miles per dollar spent. This translates into 6,000 miles! Not bad. The convenience fee is $70.50 (3,000 x .0235). Okay, how much are 6,000 miles worth? About $60.00. So you're actually $10.50 in the hole. Now, I'm using the highest fee possible because it's best to be conservative when you run these types of calculations.
But what if your bill is $6,000? In this case, you earn 12,000 miles, which are worth $120. Your convenience fee is $141.00 so this still doesn't work in your favor.
Carrying a Balance is Expensive
Okay, you're not winning the rewards battle. And here's another snag to think about. Unless you can pay the bill off completely by the due date when you receive the bill next month, you'll be paying interest on your tax payment. It's kind of unsettling to think about, isn't it?
If you carry a $3,000 balance at 15 percent interest for two years, you'll pay $145.46 per month and you'll pay $491.04 in interest during the two-year period. That's a lot of extra money to pay. The IRS notes on its site that the fees vary by provider and some of them may be tax deductible. A tax attorney will be able to advise you about this and how that impacts the actual cost of using your credit card.
Now, one way to get around this is to use a credit card with a zero percent introductory offer. This way, you put the expense on the card and make monthly payments with the goal of having the bill totally paid when the intro period ends. You're still going to be in the hole with the fee, but other than that, this can be a way to get an interest-free loan. Most intro periods right now range from a year to 18 months.
Your Credit Score Could Take a Dive
Anytime you're messing around with a high balance on your credit card, there's the potential that your score could drop. The reason is because your credit utilization ratio has gone up. Here's an example of how it works: If you have a $5,000 credit limit and you pay your $3,000 tax bill with it, then your ratio on just that card is 60 percent (3,000 / 5,000 = .60). Ideally, this needs to be under 30 percent or even 10 percent if you're trying your best to improve your score.
What Are Your Other Options?
The best choice for you depends on the specific details of your situation, of course. We've just seen that you can pay your taxes with a credit card, but it's probably not the best course of action from a cost standpoint. The IRS also accepts debit card payments and installment loan agreements. Let's a brief look at these two options:
Debit card. If you were considering using a credit card just to get the rewards and had the intention of paying the balance off the next month, then you most likely have enough cash on hand to use a debit card. When you pay taxes with a debit card, you pay a flat fee, which ranges from $2.49 to $3.95 according to the payment processors listed on the IRS website. So using our $3,000 tax bill example, you'd pay a maximum of around $3.50 to pay with a debit card compared to $70.50 for using a credit card.
The amount of the fee also depends on the amount of your tax bill. Two of the payment processors (on the IRS website) charge a $3.95 flat fee if your tax bill is over $1,000. So while choosing a payment processor, be sure you review the details so you can accurately assess the cost.
Installment agreement. You can apply to the IRS for an installment loan. If you owe less than $10,000, you'll most likely be approved. There's a one-time fee for this loan and the amount depends on a few circumstances, such as payment method and your income level. The fee is as low as $43 and as high as $120. The current interest rate is 6 percent per year.
You actually have a say in how much you pay per month, so think carefully about this. Don't overestimate your ability to pay because there are late payment penalties. You can always pay more than the minimum payment if you're doing well financially. There are forms designed for different payment methods so read the fine print carefully. If you don't understand the fine print, consult with a tax attorney or CPA. You can get more details about payment plans right here.
One advantage that an installment loan has over credit cards is the impact on your credit score. An installment loan prevents you from running up your balance on a credit card, which can increase your utilization ratio. As already mentioned, a higher ratio can have a negative affect on your score. In many cases, an installment loan from the IRS doesn't even get reported to the bureaus.