Don’t Pay Your Tax Bill with a Credit Card

A big tax bill is like hay fever. You don’t want it, you try to avoid it — and then April rolls around and it hits you hard. Now you have to figure out how to take care of it. Taxes have to be paid, and putting them on your credit card might seem a good option. Maybe you need more time to come up with the money, or you’re imagining the rewards you could rack up by putting a big expense on your card. But paying the IRS with plastic probably isn’t a good idea, and here’s why.

Downsides When You Pay Taxes by Credit Card

You’ll Pay Processing Fees

When you buy something with a credit card, the merchant pays processing fees to the financial institutions that handle the transaction. But when you put a tax payment on a credit card, the IRS doesn’t pay those processing fees. You do.

To pay federal taxes with a credit card, you have to use one of the IRS’ third-party credit card processors, which charge fees of 1.87 percent to 2 percent of the amount you put on the card. If you use software such as TurboTax to file returns and pay taxes online, the fees may be higher.

These fees could eat up your credit card rewards. Most cards offer only a 1 percent to 1.5 percent rewards rate for this type of transaction.

The exception: If you put your tax payment on a card with a 2 percent rewards rate or higher and then pay it off in full on your next statement, your rewards might exceed the fees — but just by a hair.

You Could Incur Interest Charges

“Depending on the interest rates on your credit card, you could end up paying a lot,” says Trish Evenstad, president of the Wisconsin Society of Enrolled Agents, a group of tax experts. Her advice to people who can’t pay in full: “Pay as much as you can by the April 18th due date. Then you can set up an installment agreement with the IRS to pay the remaining balance.”

For 2017, it costs $31 for qualified taxpayers to set up an installment agreement online and pay via direct debit from a checking account, according to the IRS website. That’s in addition to 4 percent annual interest on unpaid federal taxes and a penalty of 0.25 percent of the outstanding balance for each month the agreement is in effect. That works out to an annual percentage rate of about 7 percent.

It’s a much better deal than 13.61 percent, the average APR for all U.S. credit card accounts that were assessed interest in the last quarter of 2016, according to the Federal Reserve.

The exception: Paying with a 0 percent APR credit card could be more cost-effective than setting up an installment agreement, if you can pay off your balance before the promotional period ends.

You Could Hit Your Credit Limit

Charging a big tax bill on your card could put you within spitting distance of your credit limit, making it easy to max out the account and incur penalties. Your credit score could also suffer.

“I’d look at ‘What is my financial situation?’” says Cari Weston, director of tax practice and ethics for the American Institute of Certified Public Accountants. “If I need to have my credit card available for emergencies to pay for expenses because I might not have a rainy-day fund set aside, [I’m] better off not adding that credit card debt.”

The exception: If your card has a limit well in excess of your tax bill, charging it might not hamper your purchasing power or hurt your credit score much.

Better Ways to Pay

If you have the money to pay your tax bill, pay by check or direct debit to avoid fees. If you need more time, an installment arrangement with the IRS likely is your best option. Here’s what to do:

• Calculate how much time you will need. If you can pay in full within 120 days, you won’t incur a setup fee.
• Go online. An online installment agreement with direct debit is the cheapest option, with a setup fee of $31. If you set it up offline without automatic payments, it costs $225. (For state taxes, you’ll have to set up a separate payment plan with your state, which may have different rates.)
• Choose a long repayment period. To avoid falling behind on payments, Weston recommends taking the longest repayment period the IRS offers. “Commit to what you know you can pay,” she says. “You can always pay more.” Then the faster you pay it down, the more you’ll save on interest and penalties.

Republished by permission. Original here.

Credit Card Payment Photo via Shutterstock

This article, "Don’t Pay Your Tax Bill with a Credit Card" was first published on Small Business Trends