Pros and cons of paying taxes with a credit card
It's an IRS payment option, but an expensive one
Tax time can be stressful, particularly if you don't have the money to pay what you owe. While a credit card can be a convenient source for the cash, make sure you understand all the ways it will cost you.
Ideally, you should have enough money withheld from your earnings throughout the year so you don't have to scramble for cash on tax day, says Dawn W. Brolin, chief executive officer of Powerful Accounting, a CPA firm based in Windham, Connecticut. But if your savings won't cover the taxes you owe, you have to determine which form of payment will cost you the least.
While taxpayers can pay a large tax bill over time via an installment agreement with the Internal Revenue Service, some may prefer the convenience of plastic.
The Taxpayer Relief Act of 1997 forbids the
IRS from paying credit card transaction fees, so the agency has outsourced the
role of collecting credit card payments to three third-party services –
Link2Gov Corp., Official Payments Corp. and WorldPay US.
Taxpayers can pay using American Express, Discover, MasterCard or Visa. Payments can typically be made via phone, the Internet or through tax preparation software. The IRS website page "Pay taxes by credit or debit card" provides details and current prices. For taxes due April 18, 2016 (you get three additional days because April 15 is Emancipation Day), the "convenience fee" ranges from 1.87 percent to 2.25 percent of the payment for credit cards.
Those using a debit card will pay a flat fee of $2.50 to $3.95.
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The fees may be different for credit card payments made directly from tax preparation software products that offer an electronic-filing option. For example, if you do your own taxes with TurboTax and use a credit card to pay through the software's e-filing option, you'll pay a 2.49 percent convenience fee. The IRS website's "Pay by Debit or Credit Card when you E-file" page provides fees for other e-filing options.
Analyzing the costs
The fee on a $4,000 tax bill would likely cost you between $75 and $100 upfront to pay by credit card. On top of that, when you shift your debt from Uncle Sam to your card issuer, you must pay interest on whatever balance you carry. In April 2016, the average credit card rate on new card offers was 15.16 percent.
One bit of good news: You may be able to deduct the fee. The IRS provides a limited deduction, if you have sufficient other miscellaneous deductions.
Credit card users can always avoid going through those services – and paying the fee – by paying with cash-advance convenience checks attached to their credit lines.
However, you may not come out ahead financially because such checks may come with transaction charges of their own. "People always need to read the fine print," says Mark Foster, director of education for Credit Counseling of Arkansas (CCOA). "Cash advances typically have a higher interest rate than other purchases and they don't typically have a grace period."
Installment agreement option
Before whipping out the plastic, compare the costs of paying by credit card with the costs of seeking an installment agreement with the IRS. That's what Dana Andrews of Wheatfield, New York, did when he had a $15,000 tax bill. After weighing both options, Andrews decided to go with the installment plan. Typically, taxpayers get six years to pay off a debt, so your minimum monthly payment would be the total amount owed divided by 72.
Of course, you will still have to pay interest and late penalties. If you fail to file on time, the IRS charges 5 percent of the amount owed for each month that your return is late, up to five months. Once you file, you still have to pay 0.5 percent of the amount owed for each month that the payment is late. Once you set up an installment agreement, the late penalty drops to 0.25 percent per month.
The costs don't stop there. Interest, compounded daily, must also be factored in. The interest rate, which equals the federal short-term rate plus 3 percent, is set quarterly. There's also a one-time charge to set up the installment agreement – $120, or $52 if you agree to have your payments automatically deducted from your bank account.
Some low-income taxpayers can qualify for a smaller setup fee of $43. If you do select an installment agreement, know that you won't receive future tax refunds until your debt is paid off. Instead, the refunds will be applied to any remaining debt.
Rewards may not be enough
Some – including the IRS – tout using credit cards to make tax payments as a way to take advantage of rewards, such as frequent flier miles or cash back. However, card issuers typically award rewards worth 1 percent of your spending, while the third-party convenience fee could top 2 percent. "Taxpayers would likely be paying more to the third party than they would get back for redeeming points," says Michael Rozbruch, founder and CEO of tax negotiation company Tax Resolution Services.
Another option would be to open a balance transfer credit card, and transfer the tax payment to it. Balance transfer offers to people with good credit typically include an interest-free period of a few months to more than a year. A year-long promotional credit card rate of 0 percent would likely make for a better deal than the IRS agreement. "But you'd better make a plan to pay that credit card off within the year so it really is 0 percent," Brolin warns. Also keep in mind that if you are late on a payment, your interest rate could skyrocket.
Compare balance transfer credit card offers carefully. They also typically charge a fee of about 3 percent, and people with less-than-perfect credit may not qualify for a transfer covering the full amount of the tax bill.
Another thing to take into consideration: An IRS installment agreement won't impact your credit, while paying by credit card would increase your debt load. That would impact your credit utilization ratio, which could lower your score, leaving you with increased interest rates and a reduced credit line, Foster says.
Finally, it's important that you also don't overlook other options. For example, a personal loan could provide lower rates and better terms than a credit card.
Regardless of what option you choose, prepare to have more money set aside to ensure that you don't fall short next year. "If you don't make some adjustments, whatever happened this year will probably happen again," Foster says.
Updated: April 3, 2016
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