If you owe Federal income taxes and you haven’t filed for an extension, your payment is due April 17th, thanks to the fact that April 15th fell on a Sunday and the 16th is Emancipation Day. Since 1997, consumers have had the right (yes, it’s a right) to make their tax payment using a credit card. The question you have to ask before you swipe is: Am I making a mistake?
The previously referenced “right” about being able to pay your taxes with plastic is conferred by the Federal law known as the Taxpayer Relief Act of 1997. And while that law opens up the credit card option, it also has an interesting little twist. The law prohibits the Internal Revenue Service from paying the fee associated with accepting a credit card payment. You just can’t make this stuff up, folks.
Whenever you swipe your credit card, the merchant pays what’s referred to as an “interchange” fee, which is more commonly known to the layman as a swipe fee. That fee is a small percentage of the amount charged. That’s the fee the IRS isn’t allowed to pay. The good news is that rather than passing on the swipe fee to the taxpayer, the IRS deals with the card processors are non-monetary.
The taxpayer, however, doesn’t get the same consideration regarding fees. In fact, the fee you’ll pay for the “convenience” (they actually call it a convenience fee) of paying with plastic is quite chunky. Your fee will equal between 2.3% and almost 4% of your tax payment.
Credit Scoring Impact
Credit reports and scoring systems cannot tell the difference between credit card debt caused by a tax payment, versus debt caused by other purchases. As such, any negative score impact is going to be the same. And the score impact could be very significant, especially if you heavily leverage your credit card account by running up a balance that is too close to your credit limit). This will lower your credit score and put loan applications in jeopardy of being declined or approved with more expensive terms.
If you do choose to pay with a credit card, choose the card with the highest credit limit. This will reduce the impact to your score caused by a spike in your credit card utilization percentage. And, as with all credit card debt, it’s in your best interest to pay it in full as soon as possible. Paying credit card interest rates on your tax obligation balances will be painful.
The Rewards’ Strategy Doesn’t Work
I can’t believe this happens, but many consumers who can otherwise afford to pay their taxes by writing a check will choose the credit card option simply to earn rewards (points, cashback, air miles). First off, this makes absolutely no sense. Most cashback programs pay you 1% of your purchases and if you’re paying 2-4% in fees then…well, do I even need to finish that sentence?
If you’re banking on the rewards to offset the cost to pay with a credit card then, at best, you’re paying a slightly watered down fee just to float the balance for one payment cycle. That’s about as close to even as you’re going to get. Anyone that involves you paying interest blows strategy out of the water because you’re either fully or partially subsidizing your own reward.
Take, for example, points earned for airline flights. If you charge a $10,000 tax obligation it’s going to cost you between $230 and $400 to do so. At the same time, you’re going to earn 10,000 air miles. Most airlines won’t award you with a free seat until you reach 25,000 miles (if you fly at 6am and sit on the wing). But, you can probably buy your round trip ticket for the same amount you paid as the fee.
John Ulzheimer is the President of Consumer Education at SmartCredit.com, the credit blogger for Mint.com, and a contributor for the National Foundation for Credit Counseling. He is an expert on credit reporting, credit scoring and identity theft. Formerly of FICO, Equifax and Credit.com, John is the only recognized credit expert who actually comes from the credit industry. The opinions expressed in his articles are his and not of Mint.com or Intuit. Follow John on Twitter.