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Paying Taxes with Cards: Convenient, but Costly

 
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February 21, 2013

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If you owe taxes, using a credit card to pay them may seem like a good way to lessen the pain. It's quick and convenient and may even earn you some rewards.

However, before you pull your card out of your wallet, consider what it will cost you. Here is a list of some of the advantages and disadvantages of paying your taxes with a credit card:

1. Saving time: The Internal Revenue Service accepts credit card payments for taxes online or over the phone through several third-party services, including Link2Gov Corp, WorldPay US and Official Payments Corp. All four major credit card brands (Visa, MasterCard, American Express and Discover) are accepted.

The downside: Fees range from 1.89 percent to 2.35 percent, depending on which payment service you use. For a tax bill of $5,000, the fees would be between $95 and $118. If you pay through a tax-filing service, the fee can go as high as 3.93 percent.

2. Boosting your rewards earnings: For the rewards card aficionados among us, paying taxes with credit cards can be a particularly tempting proposition to rack up those rewards points. If you're trying to meet a spending requirement on a rewards card, paying your taxes with plastic can be an easy and quick way to kick up charges. It may also give you just enough of a mileage boost to earn a free flight.

The downside: Rewards cardĀ earnings average only about 1 percent per dollar spent, so paying between 1.89 percent to 2.35 percent to earn that 1 percent won't exactly put you on the road to riches.

Still, there are times when the potential for rewards earnings is higher than the fees paid. For example, if you're trying to meet an annual spending requirement to get into a higher rewards bracket, paying the extra fee may be worth it.

“Yes, charging $10,000 in back taxes with my Platinum Delta SkyMiles Card and paying $189 in fees seemed like a really stupid move,” says Terrance Smith, an Iowa-based contractor. “But it enabled me to meet the spending requirements to earn elite frequent flier status with Delta. As a result, I now routinely get upgraded to first class for free when I fly. So for me, that's about the best $189 I ever spent.”

3. Avoiding IRS penalties: Paying taxes late can cost you a pretty penny in penalties and interest charges. If you file on time but don't pay the full amount, the IRS charges 0.5 percent a month in penalties on unpaid taxes, plus 4 percent a year in interest charges. Failure to file on time is even pricier, at 5 percent in penalties per month, up to a maximum of 25 percent per year. If you don't have the cash to pay your full tax bill, a credit card can help you avoid those fees.

The downside: Unless you can pay off the credit card balance quickly and in full, credit card interest is likely to exceed the cost of the penalties and interest Uncle Sam charges late tax payers.

The IRS penalty for unpaid taxes totals 6 percent a year (0.5 percent per month), plus that extra 4 percent, for a total of 10 percent a year in extra charges. Compare that to the 14 percent to 22.99 percent interest charged on credit cards, and Uncle Sam may start looking like a veritable sugar daddy.

Just as bad, if it will take you a while to pay off the credit card balance, your credit score could take a dive.

“Lots of times we see people maxing out their credit card to pay a tax debt,” says Melinda Opperman, senior vice president at credit counseling organization Springboard. “That can really have a negative impact on their credit score, because it adversely affects the debt-to-credit ratio, the second largest component of credit scores.”

Best options for tackling taxes
If you can't afford to pay your taxes, what other option do you have? For most, the IRS installment plan will generally be preferable to using credit cards to pay a tax debt, Opperman says.

“It's comparatively much cheaper, and just as importantly, setting up an installment plan won't affect your credit in any way, because the IRS does not report to the credit bureaus,” she says.

You can apply for and automatically get approved for an IRS installment plan online if you owe less than $50,000 in taxes and penalties and have filed all tax returns due. The setup fee is $52 with automatic monthly deductions from a bank account and $105 otherwise. Interest charges are tied to the federal short-term rate plus 3 percent. With the fed funds rate at less than 0.25 percent, Uncle Sam charges only about 3.25 percent in interest a year. Not such a bad price for what is essentially a five-year loan.

Last, but not least, advises Opperman, be sure to change your W-4 withholdings, so you can avoid problems in the future. The IRS has a simple online withholding calculator that lets you estimate your total taxes. If you're an employee and find that you're getting hit with a surprisingly high tax bill every year, file an updated W-4 withholding form with your employer, so you will be one step ahead, rather than behind, come tax time next year.


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