It’s about that time again — federal taxes are due on April 18th this year. Unfortunately, if you’re like many people who struggle with debt, you may find that instead of getting a big refund that you could use to pay down your credit card debt, you owe the IRS money.
Is it a good idea to use a credit card to pay off tax debt? You may be more afraid of the IRS than you are of your credit card companies, but the experts agree that using a credit card should be among your last resorts for paying taxes.
“However, it’s better than using your 401(k) plan,” says David Jones, president of the Association of Independent Consumer Credit Counseling Agencies. “It’s also a better option than not paying your tax bill at all, because the penalties of paying your taxes late are relatively severe.”
Is tax debt really worse than credit card debt?
While tax debt is harder to get rid of in bankruptcy than credit card debt, it’s often a lot less expensive in terms of interest and fees.
If you don’t file taxes at all, you’ll owe a 5 percent non-filer penalty on the amount you owe, which will be charged each month or partial month for the first five months. You will also pay a 1/2 percent late payment penalty every month or partial month you’re late in paying, along with interest on the past-due amount.
If you do file your taxes but don’t pay what you owe — and you make no arrangements with the IRS — you can avoid the 5 percent non-filer penalty, but you would still owe the 1/2 percent late payment penalty and interest.
For someone with fair credit, the annual interest rate on a revolving credit card account averages somewhere between 18-25 percent. While the IRS penalties are assessed monthly, not annually, it’s generally a lot more expensive to pay with a credit card. Also, the credit card processing companies the IRS uses will add a 2.49 percent processing fee.
Also keep in mind that a sudden, large increase in your credit card debt can have a negative impact on your credit score, because a lot of your credit score depends on the percentage you’re using of all the credit you have access to.
“Charging a large tax bill could more easily push you into a situation where you get hit with extra fees on the card for going over the limit or getting behind on payments,” says personal finance expert Eric Tyson.
The IRS offers relatively easy, inexpensive payment plans
“[T]he IRS is cognizant of the economic problems that exist right now and is willing to be more flexible because of that,” adds Tyson.
If you owe less than $25,000 in taxes, the IRS will automatically agree to an installment agreement. It doesn’t necessarily get rid of late fees and interest, but you’ll be in good standing. You may still be able to get an installment plan if you owe more than that, but it has more steps.
According to CPA Patricia L. Cosentino, the average taxpayer won’t pay more than 7-8 percent of what they owe in interest and fees when they set up an installment agreement with the IRS, which is a lot less than most people would pay in interest on credit card debt.
Source: CreditCards.com, “Stuck with a tax bill? Here are your payment options,” Tamara E. Holmes, April 15, 2010