The IRS does indeed accept payment by plastic – a fact that leads many people to wonder about the viability of paying their taxes with a credit card.
There are various arguments to be made both in favor of and against such a strategy, and we’ll do our best to lay them out below.
- Buy Yourself Some Time: Paying your taxes with a credit card is one way to buy yourself some extra time in order to come up with the cash needed to pay off Uncle Sam. It is important to note, however, that your credit line is not the only such tool at your disposal . The IRS offers a number of options to people who cannot pay their full tax burden by the deadline, including a 120-day extension and an installment plan. It is very important that you carefully consider each option, including any and all associated costs, in order to determine which would be most advantageous based on your circumstances.
- Shift Your Obligation from the IRS: Many people simply do not want to mess with the IRS. Paying with a credit card solves that problem by enabling you to pay Uncle Sam in full and effectively shift your balance to your credit card issuer. This may prove especially important for people who are in dire financial straits, as taxes paid by credit card become dischargeable in Chapter 13 bankruptcy (not the case with Chapter 7, however).
- Long 0% Intro Terms are Available: Credit cards now offer 0% introductory interest rates for up to 18 months, which means you can prevent your tax obligation from growing while you find the cash to pay it by simply using the right card. You may even wish to use a 0% credit card if you have the requisite cash, just so you can leave your money invested for longer.
You simply need to make sure that you’ll be able to pay off your balance before high regular rates take effect and eat away at your savings. A credit card calculator will be a big help in that regard.
- Opportunity to Earn Rewards: Credit card companies are also offering initial rewards bonuses worth up to $400 to customers who can meet initial spending requirements, which are often in the neighborhood of $3,000 spent during the first 90 days or so. Using a credit card to pay your taxes is therefore an easy way to trigger an initial rewards bounty if you wouldn’t ordinarily spend the required amount. Even if you aren’t being motivated by an attractive initial bonus, the fact that you can get up to 2% cash back on purchases with the right credit card could itself make paying with plastic look attractive.
Professor’s Take: “While not often the case, it is sometimes a benefit to the taxpayer to pay off their tax obligation with a credit card,” says Jason Cherubini, assistant professor of Business Management, Goucher College. “The consistent downside of paying a tax liability with a credit card is the processing fee, often around 3% of the balance. But this downside can be offset through rewards offered by the credit card company, and low or zero percent interest offers. In addition, if bankruptcy is being considered, tax debts are not dischargeable but credit card liabilities are.”
Processing Fees: The IRS gives you the option of submitting a credit card payment through one of five processing companies. These companies charge between 1.88% and 2.35% for credit card payments, so the cost of paying with plastic depends on the amount you owe and the alternatives at your disposal.
These processing fees can also skew the value proposition of paying your taxes with a credit card for rewards purposes. This is especially true if you’re looking to earn regular transaction rewards, as opposed to trying to meet the minimum spending threshold for an initial bonus. Even the best rewards credit cards offer at most 2% cash back across all purchases.
- High Regular Interest Rates: Even the best 0% credit cards have regular rates ranging from 9.99% to 24.99%, which can make any balance leftover at the end of the 0% intro term grow fast. You must therefore make sure that you can comfortably afford the monthly payments required to be debt free by the end of the intro period in order to maximize the value of this strategy.
- Credit Score Damage: Taking on a significant balance with your credit card always comes with the risk of credit score damage. If you cannot afford to make the monthly payments, delinquency will be noted on your credit reports and it will become much harder to take out a loan, rent an apartment or buy a car. Your insurance premiums may even rise. That is why it is so important to use a credit card calculator prior to paying your taxes with plastic in order to determine the monthly payments you have to make in accordance with a certain payoff timeline.
Professor’s Take: “Generally it does not make financial sense to pay your income taxes with a credit card if you will carry a balance,” says Michelle Lyon Drumbl, Director of the Washington & Lee University School of Law Tax Clinic. “If you enter into an installment agreement with the IRS, you’ll be charged interest and a penalty. However, these charges combined will typically be lower than the interest and fees on a credit card balance.”
Preparation is the key to ensuring that paying your taxes with a credit card pays off in the long run. It’s therefore critical that you use a payment calculator to determine how long it will take to get rid of your balance, which will include up-front processing fees. In doing so, make sure to give yourself some breathing room because preparing for only the best-case scenario is a recipe for trouble.
If you’ll be able to comfortably pay off what you owe fast enough to prevent fees and interest from exceeding the costs of other repayment options or your expected rewards earnings, then you’re on the right track. However, before you finalize your plans, you’ll need to make sure that you can actually get approved for a card with a long enough 0% introductory term or lucrative enough initial bonus to make the process worthwhile. It can take up to a couple of weeks to get a new credit card in your hands, so it’s especially important to start your tax planning well in advance if you’re considering paying with plastic.