Managing Debt

4 Reasons to Avoid Paying Taxes with a Credit Card

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Taxes_Chris_Young_CCFLickrThe IRS suggests that paying your taxes with a credit card is a convenient and safe way to pay Uncle Sam. It might be convenient and safe, but it isn’t cheap. Here are four reasons you shouldn’t pay your taxes with a credit card:

#1: Convenience fees are added to your payment

You can pay taxes with a credit card, but you’re not making the payment directly to the IRS. The IRS is using third-party service providers that charge convenience fees ranging from 1.90 percent–3.93 percent of the amount you owe. You can see a full list of providers and the fees they charge on the IRS website.

But here’s an example to give you an idea of how much this costs. On a $2,000 tax bill, you could pay around $47 ($2,000 x .0235) if you use a service provider with a 2.35 percent fee. You’ll be informed of the fee amount before the payment is authorized. But do you really want to give the IRS an extra $47? I didn’t think so.

Now, sometimes life doesn’t go the way we expect it to. If you’re having cash flow issues and you simply have no other alternative than to use your credit card, you’ll be pleased to know that the convenience fee is tax deductible. For an individual expense, taxpayers may deduct the fee as a “miscellaneous itemized deduction” on Form 1040, Schedule A. But the deduction is subject to the 2 percent limit, so discuss this with your tax preparer.

Note: If you’re thinking of using a debit card, there’s a flat transaction fee up to $3.95 for all but one of the service providers.  See the list of providers for more details.

[Related article: Pay Your Taxes With Plastic? Beware.]

#2: You could end up paying interest on your IRS payment

If you don’t pay the credit card bill in full before the grace period ends, you’ll be paying interest on your tax payment. Let’s do the (very simple) math to illustrate what can go wrong here.

Let’s say your credit card APR is 15 percent and you manage to pay the $2,000 payment off in one year. Your payments would be $185 per month and you’d end up paying $170 in interest. So now you’ve paid the IRS $2,217.00 ($2,000 + $47 + $170) and you only owed $2,000. And guess what? It’s a year later and it’s time to pay your taxes again.

And even if you have a card with a zero percent introductory APR for 12 months, you’re still paying an extra $47 for the convenience fee. I don’t mean to harp on this, but I think we all pay enough taxes already.

#3: Using a credit card could raise a red flag to your issuer

Whether it’s true or not, paying your taxes with a credit card can make it look like you’re desperate for cash, which can create an impression that you’re suddenly a credit risk. The payment will also reduce the amount you have left on your credit limit. This decreases your revolving utilization ratio, which can also lower your credit score.

From the issuer’s point of view, they might start worrying about your ability to pay your bills. This could lead to a decrease in your credit limit, an increase in your APR, or other unpleasantness. If you do end up using your credit card, paying it off quickly should help dispel any notion that you’re in dire straits financially.

[Credit Card Roundup: Credit Cards for Rebuilding Credit]

#4: The rewards usually aren’t worth it

Using our example, if you pay off your balance right away, you’re spending an extra $47 to pay your taxes with a credit card. If you’re getting 2 percent cash back (and that’s pretty generous), that’s $40.94 ($2,047 x .02). You’re in the hole by a little over $6. And remember, some cards have thresholds and caps. So if the pursuit of rewards is the driving force here, make sure you read your rewards program details carefully so you can determine if this makes any sense for you.

Image: Chris Young, via Flickr.com

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