Should I Pay My Taxes with a Credit Card?
Under the Taxpayer Relief Act of 1997, the IRS gave consumers the right to make their tax payments with a credit card. Sounds easy and convenient, especially if you’re able to pay the balance off at the end of the month, right?
And what about the credit card rewards lovers out there? If you’re planning to pay off the balance anyway, and have the cash on hand to do so – why wouldn’t it make sense to take advantage of the rewards perks? Here are some downsides to consider before using a credit card to pay your taxes.
The Considerable Price Of “Convenience”
Usually, when you swipe your credit card for a purchase, the merchant pays what’s called an “interchange” fee to a third party payment processor in order to “process” the transaction. This fee, more commonly known as a “swipe fee,” is equal to a small percentage of the total amount charged on the card.
The IRS, however, doesn’t cover this fee and because the fee has to be paid in order for the payment to be processed — the fee is passed on to the taxpayer (aka, YOU). The IRS won’t accept your payment directly, but rather they provide a list of third-party companies that they’ve authorized to accept tax payments on their behalf. And since these companies won’t be collecting the fee from the IRS, they’ll charge you a fee of anywhere between 1.88-4% of your total tax payment and call it a “convenience fee.”
Rewards That Don’t Add Up
For all the diehard reward lovers that would rather pay their taxes with their credit card just to earn rewards–whether it’s cash back, points or miles, the math just doesn’t add up. Let’s start with cash back rewards as an example.
If you consider that most cash back rewards programs pay 1% of your purchases but you’re paying 1.88-4% in fees — it doesn’t take a math whiz to figure that one out. Arbitrage is not in your future. Then there are the points and miles rewards, where some may argue that rewards would offset the fee. If you’re paying interest to subsidize your own reward, the math also doesn’t add up.
Stay with me here…let’s say you use an airline rewards card to pay a $10,000 tax payment in order to earn 10,000 miles. The convenience fee will cost you between $188 and $400, and considering that most airlines require a minimum of 25,000 miles to earn a free flight–the cost still doesn’t add up. Instead of spending the money on the fee, it would make more sense to use that money to just buy the ticket outright.
Large Charges Equal Lower Credit Scores
Before you charge a tax payment it’s also important to consider the possible impact to your credit score. Because a large portion of your credit score is based on your credit card utilization (the balance to limit ratio), using a credit card to make a high dollar tax payment could have significant impact on your credit score.
As an example, if your tax payment is significant, like the $10,000 example I used previously, it can quickly eat into your available credit limit by running up your balance and spiking your revolving utilization–which can in turn, tank your credit score. Granted, you could minimize the impact by choosing a card with the highest credit limit – but even then there will be a negative impact.
Using a Credit Card to Pay Your Taxes May Be Cost-Effective If You’ve Underpaid
If you owe taxes due to having paid too few estimated quarterly taxes throughout the year (which apply to freelance, self employment, or capital gains you may have realized) you may be subject to an underpayment penalty. Though there are many factors to the exact amount you’ll be charged, it’s essentially based on a penalty rate of about 3%. Because the formula considers the number of days that have passed since the underpayment, resolving it as soon as you can is in your best financial interest.
If you have a 0% interest credit card that you can put the payment on in order to “stop the clock” on the penalty and are confident you can pay the balance off before the card’s rate increases, charging the tax bill may be a more cost-effective solution than waiting until you’ve got the cash on hand.
Regardless of whether you’ve been granted an extension to file your return until October 15th, you must figure out what you’ll owe the IRS (if anything) by April 15th and pay the bill, or make arrangements for how you’ll pay it, by that time. After April 15th, late payments are subject to a “failure-to-pay penalty of ½ of 1% of your unpaid taxes, which applies for each month or part of a month after the due date and starts accruing the day after the tax-filing due date,” according to the IRS’ website.
If you find yourself in this situation, placing your tax bill on credit may be worth considering if you have a lower interest credit card, and know that the charge will not push you past a 30% debt utilization ratio. But, if charging your taxes means you’ll carry the balance on a higher interest credit card for awhile, you’ll have to consider if paying the IRS’ credit card processing fee, the interest rate on your card, and possibly lowering your credit score because you’re using too much available credit is a more positive scenario than establishing a payment plan with the IRS–which can include processing fees as high as $120.