Credit Sesame discusses how tax debt may impact your finances and credit score.
Not paying bills on time and owing money to creditors usually lowers credit scores. If you fail to pay your income taxes on time your credit score is not affected. At least not directly.
The Internal Revenue Service does not report tax debts directly to consumer credit bureaus, so credit scores won’t fall. Credit card companies, mortgage lenders and other creditors report debts, but not the IRS.
Federal tax liens could hurt
If you owe the IRS a lot of money, it could file a Notice of Federal Tax Lien in court. A tax lien gives the federal government a legal claim to every asset you own, such as your car, home or other property. The lien gives the IRS first priority over other creditors in collecting on the lien.
You probably get to keep your property, but a lien makes it difficult to sell. Ultimately, however, the IRS could force a sale of your assets to collect any unpaid taxes, penalties and interest you owe.
The credit bureaus stopped reporting tax liens in April 2018, so liens cannot lower credit scores. A lien by the IRS does not appear on your credit reports.
But lenders can still discover tax liens through public records searches when considering your application for a mortgage or other type of loan. They may deny your application based on a tax lien. Landlords and employers may also view the tax lien, which could make it hard to rent an apartment or get a job.
Paying tax debt by credit card or personal loan
You can pay an IRS bill with a credit card or a personal loan. Late repaying of either of those loans could affect your credit scores since credit card and loan transactions are usually part of credit reports and your credit score.
The IRS accepts credit card payments through three processors, with interest rates from 2.35% to 2.95% of the balance charged. Two credit card processors also charge a minimum convenience fee of $3.95.
If you fail to pay off a credit card balance completely within one billing cycle, the debt on your credit card could be reported to the credit bureaus and could raise your debt. Using more than 30% of your credit utilization ratio (the credit balance in relation to how much you can borrow) can lower a credit score.
The same goes for a personal loan, and paying either loan late can also lower credit scores. Personal loans have the advantage of having a set number of fixed payments for a certain amount of time, such as two to five years. This can make budgeting easier than credit card bills, which have varying payment amounts that can last for an indefinite period.
The good news is that if you repay a personal loan or credit card balance on time and in full, then your credit score is more likely to rise.
Consider an IRS payment plan
Before a federal tax lien is imposed, the IRS gives you plenty of notice to pay your outstanding tax bill with payment plans and other options.
Payment plans are preferable to liens. Setting up a plan with the IRS when you receive a tax bill does not trigger reports to the credit bureaus. IRS payment plans are not considered loans and do not affect credit scores.
The IRS has many payment plans. A long-term payment plan from 120 days to six years requires owing $50,000 or less in combined taxes, penalties and interest. No setup fee is charged.
A short-term plan of 120 days or less allows a tax bill as high as $100,000. Setup fees of up to $225 are required, though the interest rates are relatively low at 3%.
It is important to make every payment on time. A missed payment results in the whole amount becoming due immediately, along with penalties and interest.
10 years to collect tax debt
This is no preferred way to get out of a federal tax lien, but the IRS has a 10-year statute of limitations on collecting tax assessments. In theory, you could wait out the IRS for 10 years, when the IRS can no longer legally try to collect taxes you owe. That clock starts on the date of assessment for each tax year.
If you intentionally try to defraud the IRS, called tax fraud, there’s no statute of limitations and the IRS can charge you with a crime at any time.
Other ways to manage your taxes and credit scores
Paying your taxes on time is the best solution. If possible, avoid paying with a credit card or loan so there is no way for your credit score to be impacted.
One way to ensure you’re paying enough taxes is to check the withholding amount through your employer. The IRS has a tax withholding estimator online to help workers estimate how much federal income tax should be withheld so that they don’t owe anything later.
This pay-as-you-go tax is easier via payroll during the year than with a surprising amount at tax time. You can change your withholding amount at any time and should check it early in the year, especially if you’ve experienced a life change such as a marriage, home purchase, birth or retirement.
If you ever do get a letter from the IRS, pay attention. Failing to pay your taxes on time is a serious matter, and the worst case is that you face a tax lien and could lose your home and other assets to pay the bill. Starting an affordable payment plan early can make that outcome much less likely.
Two ways to improve your credit score are by paying all your bills on time and not carrying too much debt. While tax debt itself does not affect credit scores, failing to repay a loan used to cover tax debt may impact credit scores.
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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.
