One of the worst feelings you can have is the realization that you owe the Internal Revenue Service (IRS) several thousand dollars in taxes.
Imagine the scenario: After years of receiving refunds from the IRS, you neglected to adjust your withholding to account for your big raise and bonus from last year – a minor detail.
Numb from the shock, you wonder how you are going to pay them. Then you remember the new cash back rewards credit card you received last month with a nice $5,000 credit limit.
You start to feel better because you figure you can earn a chunk of cash back while taking care of the IRS bill. It seems like a great idea. But, given the chance to crunch the numbers and explore other options, it could turn out to be the worst thing you can do. Here’s why:
Why You Should Avoid Paying Your IRS Bill With a Credit Card
You’ll Pay High Processing Fees
Generally, when you use your credit card it results in a transaction fee, but you usually don’t see it because it’s covered by the merchant. When you use your credit card to pay your taxes, you not only see the transaction fee, you have to pay it.
That’s because the tax code forbids the IRS from directly accepting credit cards.
You will actually make the payment through a third-party service that will charge you a “convenience” fee ranging from 1.87 percent to 2 percent. If you use tax preparation software that includes e-file and e-pay, such as TurboTax, the fee can be as high as 2.49 percent.
It May Hurt Your Credit
When you use that credit card with a $5,000 credit limit to pay your large IRS tax bill, say $4,000 for example, your credit utilization ratio will shoot up to 80 percent on that credit card.
If that is your only credit card, or you have high credit utilization on your other credit cards, your credit score will likely plummet. Your credit utilization ratio accounts for 30 percent of your credit score.
If you don’t pay attention to your credit score, then you may have trouble qualifying for loans and other credit cards in the future.
Interest Cost Will Hurt You
Unless you expect to pay off your credit card balance quickly, you could end up paying a lot more for your taxes than you imagined.
If your annual percentage rate (APR) is somewhere around the average national rate of 15.72 percent, and you only make minimum monthly payments it will take you 16 years to pay it off and your total IRS tax bill will have grown to more than $8,500.
Credit Cards Likely Aren’t Rewarding Enough
The idea of earning a bucket of rewards points for paying a big IRS tax bill with your credit card seems alluring, except it really doesn’t pay off.
With a minimum convenience fee of 2 percent, your rewards rate on miscellaneous purchases would have to be at least 2 percent, which is rare.
If you can cover the convenience fee with a cash back reward, then at least you can break even. The only exception is if you use a new credit card that offers a big bonus on initial purchases.
When It Might Make Sense to Use Your Credit Card
Getting past the worst case scenario, there may be some circumstances in which using a credit card to pay your IRS tax bill could make sense.
When You Can Pay the Balance Quickly
If you have the ability to pay off your credit card balance within a relatively short period of time, it may not have to cost you an arm and a leg.
Obviously, if you could come up with the $4,000 all at once to pay the balance in full quickly, you minimize your costs. At the very least, you should be in a position to pay the balance down within a 12-month period.
In the above example, your payment would be around $370 a month for a total of $4,440. That is an extra cost of $360 on a total amount financed of $4,080 (including $80 fee).
When You Can Use a Zero Percent Balance Transfer
If you are in a position to pay down your balance within 12 months, you would be slightly better off if you have access to a zero percent introductory rate balance transfer credit card.
Although you wouldn’t owe any interest if the balance is paid in full before the expiration of the introductory period, you would still pay the balance transfer fee of 3 percent. So your total cost, including convenience fee would be around $4,200 using your credit card.
All bets are off, though, if you fail to pay the balance in full before expiration of the introductory period.
Your Best Option
If you don’t have the money to cover your total IRS tax bill, your best option would be the installment agreement offered by the IRS.
If you owe less than $50,000 and are current on your taxes, you can usually qualify for an installment agreement. The agreement is based on what you can afford to pay each month, but it has to be paid within five years.
You will pay a processing fee of $31 to setup a direct debit to your checking account.
Author: Jeff Gitlen
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