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03-04-2013, 12:20 PM #1
Paying Taxes with a Credit Card: Warning Read This First!
Can't afford to pay your tax bill in full? You can pay late (and face the fees), set up a payment plan for a costly one-time fee or pay with your credit card. You may even be thinking about whipping out the card just to earn some hefty rewards. After all, you're just a few hundred points away from an airline ticket, why not?
Before you pull out your credit card to pay the tax man, there are a few things you should consider first. It might not be the smart move it seems.
The Convenience Fee May Be Higher than Rewards!
So, what's the biggest problem with paying your state or even federal taxes with your credit card? That convenience fee. All credit card companies charge a fee when merchants accept credit cards and most of the time the merchant simply passes this along to you as a consumer with higher prices. When it comes to taxes, this is passed on in the form of a convenience fee.
If you pay your tax bill with your credit card, you'll likely use one of these authorized payment providers:
- payUSAtax - 1.99% fee with a minimum of $2.69
- Pay1040.com - 1.87% fee with a minimum of $2.59
- Official Payments - 2.35% fee with a minimum of $2.50
If you're paying a tax bill of, say, $2,000, you're looking at a fee of $47. If your credit card earns you 1% cash back, that only equates to $20 back. Some convenience fees are even as high as 3.93!
Now the Second Problem... Credit Card Interest
The next problem comes when you factor in the interest rate you'll be paying on your credit card balance. Pay with credit and you could be paying that tax bill for years at a hefty interest rate and you might end up paying double or even triple the original amount. If your credit card isn't low interest or you don't have a 0% promotional period, we recommend an installment agreement with the IRS, which we'll discuss in a moment.
The Debt Can't be Discharged in Bankruptcy
One important thing to remember is you can't discharge income tax debt (in most cases) through bankruptcy, even if you put it on a credit card! Occasionally people in financial trouble think they can bypass this rule by paying a large tax debt with credit and then declaring bankruptcy a few months later.
The Unforeseen Consequence: Your Card Issuer Views You as a Risk!
There's another downside to paying taxes with a credit card that many people don't consider: your credit card issuer may think you're in financial trouble. We've covered in the past how credit card companies track your spending and using your credit card at certain retailers -- or paying your taxes -- could trigger an increase in your interest rate, a lowered credit limit or even a canceled card.
Imagine putting a large tax bill on a very low interest credit card, thinking you're saving money, only to have your card issuer raise your interest rate and cost you thousands! This happens more often than you can imagine.
When Paying Taxes With a Credit Card Makes Sense
If you can't afford to pay your bill by April 17th any other way, using your credit card can save you money. If you pay your tax bill late, the IRS will start to charge you interest from the date it was due until it's paid in full, and the failure to pay penalty. This is how it breaks down:
- The failure to pay penalty is based on how much you owe and it's 0.5% for every month the tax isn't paid in full. There's also no maximum limit for the penalty.
- Interest rates change every quarter but they're currently 3.5% per year, which is calculated for every single day you don't pay in full, beginning with the due date.
If you're a year late to pay your bill, you could be looking at a 9% increase in the amount you have to pay. Let's say you pay your taxes with a credit card instead to avoid this. If you use a low-interest card with an APR of 4% -- and pay that one-time convenience fee from a third party of 2.4% -- you would pay around 6.4% total instead of 9%. This means you'd save $260 on a $10,000 bill. Use a 0% interest credit card and you'll save even more, unless you carry your balance past the promotional period, in which case you're worse off.
You might also benefit by paying with a credit card if you'll get airline miles and use them on upgrades -- provided the value of the rewards is higher than the convenience fees. It can also be a good move if paying your taxes helps you qualify for a credit card introductory offer that requires you spend a certain amount within the first 3 months.
With the Chase Sapphire Preferred card, for example, you'll only get the 40,000 bonus points if you spend $3,000 during those first 3 months. In this case, the value of the bonus (assuming you wouldn't otherwise get it) can exceed the cost of the convenience fee you'll pay.
Can't Afford to Pay all at Once? Get an Installment Agreement
For most people, the best option for a hefty tax bill is an installment agreement with the IRS. This will reduce your late payment penalty to only 0.25% The IRS also announced a new program to help people who need more time to pay with a 6-month grace period on this failure-to-pay penalty if you're self employed or fall into a certain wage earner category. Request an extension and you have until October 15 to pay your bill.
Setting up an installment agreement comes with a one-time $105 fee, which may only be $52 if you set up direct debit or $43 if you meet the low income threshold. While you'll pay interest during the installment plan, it's only going to be 4%, which is lower than most credit cards.
Alternatively,if you just need a little more time, you can apply for a 120-day payment extension. You will not be charged an application fee for this type of short-term extension, but you will still have to pay the 3.5% interest and 0.5% monthly late fee on your balance.
A Little Overwhelmed? Here's the Short Version
Don't pay taxes with a credit card if:
- You don't have a 0% introductory APR on your credit card and you can't pay the balance off before the promotion ends,
- You don't have a very low interest credit card,
- The rewards you earn won't cover the convenience fee and interest you'll pay, or
- An installment agreement with the IRS is a better move financially.
It makes sense to pay with a credit card if:
- You'll qualify for bonus points that exceed the convenience fee and any interest you'd pay,
- You'll get airline miles for an upgrade that more than covers the convenience fee, or
- You have a very low interest or 0% interest card and paying the convenience fee and interest works out to less than you'd pay if you paid late or using an installment agreement.
Last edited by CreditDave; 04-12-2016 at 12:22 PM.Bad Credit? Read This >> The Ultimate List of Resources For Building Your Credit
03-04-2013, 12:40 PM #2
I made this mistake once but never again. I pay quarterly now which breaks it up a bit so I'm not stuck with a huge bill at the end of the year anymore.. it only became a problem after I started my business and didn't have taxes automatically taken out of my paycheck each week but very easy to get behind if you aren't careful.Need a Card to Build/Rebuild Your Credit With? Read This >> Best Credit Cards For Building Your Credit
04-19-2014, 03:07 PM #3
It is easy to get behind on taxes if you are not careful. It is something every business owner should think about from the very beginning. It is also not a good thing to pay interest to Uncle Sam on what is owed and the penalties which can also be added to your account. Setting aside money ahead in the year is another way to have the money available before it is due.