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Each year, when April rolls around, millions of Americans scramble to come up with the money to pay the Pied Piper, a.k.a. Uncle Sam. Well, for people coming up short with money to pay their taxes, there’s a temptingly easy way to remedy the shortfall-pay the taxes with your credit card.
However, is paying taxes with credit cards such a good idea? Not really, for a number of reasons. To begin with, charging your taxes to your credit card incurs an extra fee from the IRS. This fee usually hovers around 2.35 percent, but could go as high as 3.93 percent if you pay through a tax-filing service. The IRS isn’t charging tax payers who pay with credit cards more, they are simply passing on the so-called merchant fee, a processing fee which credit card companies charge on all credit card transactions. The same fee is paid each time you pay by credit card in stores, however, in that case, retailers pay the fee, or, just as commonly, pass the fee on to consumers in the form of higher prices.
In other words, unless you’re trying to meet a spending bonus incentive on a rewards credit card, you are unlikely to profit from putting your taxes on plastic. Depending on how much you owe, the fee for paying with a credit card can quickly add up. A contract worker who owes $11,000 in taxes, for example, will be saddled with an additional $260 to $432 in fees. Even if he accrues rewards points or cash back on the card, rewards credit card earnings typically amount to only 1 percent of the transaction amount, which means he’s still paying a hefty premium for the pleasure of paying with plastic.
In addition to the transaction fee the IRS charges for paying taxes with credit cards, you’ll also, of course, be paying credit card interest on the amount until it’s been paid off. With credit card interest rates ranging from 12 to 24.99 percent APR, that easily adds up to a significant amount, in addition to the 2.35 to 3.93 percent transaction fee, unless of course you plan on paying the balance off quickly.
If you don’t have to the money to pay your tax bill in full, what’s the alternative? Borrow from Uncle Sam instead of your credit card issuer. While it’s true that the IRS charges you a monthly penalty fee plus interest on unpaid taxes, Uncle Sam turns out to be much more generous than credit card companies. For taxes filed on time, the IRS charges a 0.5 percent penalty fee per month, or 6 percent on an annualized basis, plus interest, which currently is at 4 percent APR. That corresponds to 10 percent APR—not too bad if you need a little extra time to come up with the unpaid taxes. Interest is calculated based on how much tax you owe, and is compounded daily. The interest rate is the Fed short-term rate plus 3 percent; it adjusted every three months. After the IRS issues a notice of intent to levy, the penalty rate increases to 1 percent per month or 12 percent, plus the 4 percent interest per year corresponding to a 16 percent APR.
Be wary of filing late, however, for late filers the penalty is much steeper: 5 percent per month on the unpaid taxes due, up to a maximum of 25 percent. Ouch. However, if you have a refund coming, there is no penalty for filing late, as penalties are calculated on the amount due.
If your main motivation for paying taxes with plastic is convenience, a debit card transaction may be your best option. Debit card fees are capped at dollar amounts, so you can expect to pay a mere $3.89 to $3.95, depending on which government payment service you choose.
