Guest post by Thursday Bram
Not so very long ago, one of my friends forgot to pay taxes. It was his first year working for himself and he just didn’t really think about the quarterly estimated taxes he might owe. So, when April rolled around, he got a horrible surprise: almost $20,000 in due taxes. He put it on his credit card.
Now, putting that large of a tax bill on the credit card isn’t incredibly common — but putting a small tax bill, like a few hundred dollars, on a card is pretty common. In part, that’s due to the fact that we think about those pieces of plastic as easy money, an easy way to let us get the IRS off our backs and let us pay off the bill in our own time.
The Big Problem with Credit Cards and Taxes
That friend with the tax bill found the pitfall in using your credit card to pay your taxes the hard way. The interest builds up fast. For my friend, that decision set him on a path that led directly to bankruptcy — which is even harder to face when you realize that the IRS’ interest rate on unpaid balances is almost always lower than the rate on your credit card. The IRS’ rate does compound in such a way that it can add up, but you can contact the agency and set up a payment plan, just as you might pay your credit card bill every month.
You might be thinking that, as long as you have your full payment in hand, you might as well use your credit card and pick up some airline miles or other perks. But that still can be a less-than-ideal choice. Because the IRS wants to be sure that it gets the full amount of taxes that it is owed, it passes the service charge along to tax payers: you’ll be charged a fee to pay by credit card that is almost always more than the value of the credit card rewards you might earn.
There Are Long-Term Consequences, Too
Paying your tax bill with a credit card can be the situation that keeps coming back to haunt you, even if you’ve been paying your bills on time and the interest isn’t going to be overwhelming. Creditors do analyze where you use credit (it’s a way to see early warning signs that an individual is becoming a higher risk). If they see a charge from the IRS on your statement, it can be considered a warning sign that there is a problem with your finances — after all, most people don’t consider a credit card their first choice for paying the IRS.
And if a situation ever gets so bad that in lands in bankruptcy court, a tax bill on your credit card doesn’t go away like most credit card debt can. By law, income taxes are a debt that cannot be discharged in bankruptcy court. That means that if a person is low on cash, it makes more sense to use cash on paying his taxes and use the credit card to pay the bills — although it’s even better to avoid the situation entirely.
Thursday Bram writes for CreditScore.