Tax season is back upon us. The subject of taxes always raises plenty of questions – including about credit scores. Do your taxes affect your credit score? Here is what you need to know:
How Your Taxes Can Hurt Your Credit Score
So, can your tax bill directly impact your credit score – yes, but only if you make a few critical mistakes.
Paying Taxes with a Credit Card
Paying taxes with a credit card isn’t common, but it is possible. Various services allow U.S. residents to pay their taxes (and back taxes) with credit cards. These services come with an additional service charge, which the IRS lays out on their website:
- PayUSAtax – 1.96% of the transaction costs ($2.69 minimum)
- Pay1040 – 1.99% of the transaction costs ($2.58 minimum)
- ACI Payments, Inc. – 1.99% of the transaction costs ($2.60 minimum)
The main benefits of paying taxes with a credit card include the ability to finance tax bills over a longer period and the ability to earn reward points. These benefits, however, must be balanced with the potentially harmful ramifications of paying taxes with your credit card – including missed payments and hits to your credit score.
Missing payments with a credit card will result in a negative impact on your credit score. And, since both FICO Score and VantageScore place their greatest emphasis on payment history – missing one payment can reduce a person’s credit score by 30 points – or more.
If your tax bill is significant, putting that balance on a credit card can negatively impact your credit score. Credit utilization (or overall credit use) plays a vital role in a person’s credit score. Keeping overall credit usage below 30% is crucial for maintaining a healthy credit score – and a large tax bill can quickly send credit utilization towards 50% or higher.
Related Article: Can You Pay Your Taxes with a Credit Card?
Paying Back Taxes with a Personal Loan
Repaying taxes owed with a personal loan is another way your income taxes can impact your credit score. Paying your taxes with a personal installment loan provides the opportunity to repay that debt over time. In this way, personal loans offer one of the same benefits of paying taxes with credit cards.
Many personal loans also feature lower interest rates than a credit card, making it an enticing proposition. Since many excellent credit cards feature 0% introductory APR, personal loans aren’t always the best option.
Can an IRS Installment Agreement Hurt Your Credit Score?
Personal loans and credit cards may harm your credit score when used to pay taxes, but what about an IRS installment program?
The IRS offers several installment repayments programs for taxpayers who owe money on their income tax or other tax returns. These IRS-backed programs provide 120-day (or longer) repayment plans that are negotiable based on how much a person owes.
IRS installment plans offer two significant benefits to those who owe a sizeable tax bill: low interest rates and no credit score impact.
Interest rates with IRS installment plans are typically around 3% APR, much lower than many personal loans or credit card interest rates. However, keep in mind that longer, negotiated plans come with setup fees, and late penalties apply to short-term repayment plans. These late penalties are 0.25% of the entire balance every month until the tax bill is fully settled.
Additionally, IRS installment plans are not considered a personal loan. This status means that the loan will not have any impact on the credit score of an individual. For this reason, a government-backed installment plan may be your best bet for paying back taxes. Keep in mind that failure to repay the balance on an IRS installment may result in tax liens on your property and other negative impacts.
How you pay your taxes can have a direct impact on your credit score. Using credit cards and personal loans to finance back taxes can provide some breathing room and the ability to pay down taxes over time but comes with the potential danger of missed payments and high credit utilization.
IRS installment plans provide the safety of no direct credit impact but come with late fees and the potential for tax liens on your property for failure to repay what you owe.
Ultimately, paying taxes won’t have any negative impact on your credit score for most Americans. Just be careful to ensure you pay what you owe, abide by the terms of any loan agreements (including cardmember agreements), and you should be safe this tax season.
Related Article: Why Are My Credit Scores Different?