Have you filed your taxes yet? It doesn’t matter if you’re new to the tax game, lost track of time or are in a financial bind — nobody can evade paying what’s due. Comparing what you owe to the IRS against money in the bank and wondering if it affects your credit score and credit report to pay taxes late? It certainly can.
The most severe repercussion for paying taxes late is a tax lien. The IRS will automatically file a lien against your property if you do not pay, make arrangements to pay, or request a hearing refuting your tax penalty within 30 days of initial IRS contact (typically a lien will be filed if you owe $10,000 or more). Like other public records, tax liens can have quite a negative impact on your credit score. Once the debt is paid and released, the lien still remains in your credit history for seven years. It is important to note that liens are not commonly erased even if you file bankruptcy so until the amount is paid in full, your credit score will be affected.
Let’s hope that the inability to pay taxes does not get that far. There are, however, smaller missteps that can snowball into substantial tax-related credit problems.
Prepare for penalties
The IRS doesn’t care why you are filing or paying taxes late — you will still accumulate penalties. Owing taxes can be a financial burden, but taking on unnecessary fees can make for a tricky financial future.
The failure-to-file penalty is 5 percent of your unpaid taxes. This penalty will accrue each month, or part of a month, that a tax return is late, starting April 16. These fees will not exceed 25 percent of your unpaid taxes. So, if you owe $100,000 in taxes, the most you’ll amass in penalty fees is $25,000.
The failure-to-pay penalty is usually 0.5 percent of your unpaid taxes. The failure-to-pay penalty will start to accrue monthly beginning April 16. If there is interplay between the failure-to-pay penalty and failure-to-file penalty the maximum penalty assessed is 5 percent.
Late payments and credit impact
You’re late to pay. Penalties are piling up. You don’t have the cash. What payment options are there? This is where your finances and credit score can take a hit in the blink of an eye.
- The best option to avoid credit score implications is an installment agreement, which enables qualified individuals who file their federal taxes by April 15 to knock out their tax debt with monthly payments instead of one lump sum. Keep in mind that you will pay a processing fee.
- Don’t qualify for an installment agreement? You may request from the IRS a short additional time to pay your tax in full. Taxpayers who request and are granted an additional 120 days to pay the tax in full generally will pay less in penalties and interest than if the debt were repaid through an installment agreement over a greater period of time. There is no fee for this short extension of time to pay, according to IRS.gov.
- Paying with credit cards can impact your credit for a couple reasons. If you plan on applying for a new credit card to settle your debts, remember a hard inquiry will show up on your credit report and has a slight negative impact on your credit score. Putting the amount of taxes owed solely on a card can raise your utilization rate, which determines about 30 percent of a credit score. You’ll also pay interest on debt carried on the card. Additionally, the IRS charges service fees for tax-based credit card transactions, currently 1.87 percent of the amount owed.
- Personal loans may feature lower interest rates than credit cards for applicants with the right credit score, which may be useful if you owe a significant amount in taxes. As with credit cards, applying for a personal loan results in a hard inquiry which will result in a minor drop on your credit score. However, diversifying your credit portfolio with an additional type of debt, if paid off dutifully, may also improve your credit score in the long run.
- Considering if you should take from an IRA or 401(k) to pay your tax bill? Please don’t withdrawal from your retirement plans, especially if you are under age 60. Although the impact on your credit score will not be instant, dipping into your retirement plan will immediately cost you money. If you take from your retirement plan expect to pay at least 30 percent in IRS and state taxes, early withdrawal penalties, and any fees you’re already incurring for filing late taxes. Prolonged impacts on your credit score may emerge while finding ways to pay for additional fees and penalties assessed from taking from your retirement.
- Homeowners may ponder borrowing against the equity built up on their home. A home equity line of credit (HELOC) usually offers low interest rates, and can even be tax deductible. A HELOC looks similar to a credit card on a credit report: it is treated as revolving credit, and based on your balance and payment history your credit score will fluctuate. A HELOC is a hefty decision because you are putting your home on the line, and if you fail to make payments your credit score won’t be the only thing to lose.
The preceding financial practices should never take precedence over budgeting. In order to get yourself out of plight next time, try setting up a tax savings account.