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Learning that you owe a large tax bill to the IRS can be overwhelming, not to mention stressful. If you need to make a payment to the federal government this tax season, you may have questions, such as whether delaying or not paying your taxes can hurt your credit.
While an unpaid tax bill may not directly affect your credit, it can lead you down a path with serious negative consequences for your financial situation, including hurting your credit scores.
How Unpaid Taxes Impact Your Credit
Unpaid taxes don't have a direct impact upon your credit anymore. This hasn't always been the case. Prior to April of 2018, tax liens were commonly included on credit reports with all three credit reporting agencies—Experian, TransUnion and Equifax.
Now that tax liens no longer show up on credit reports, they don't have any direct influence on your credit scores either. Even so, unpaid taxes can still cause you a lot of problems.
Ways Not Paying Your Taxes Could Hurt You
You could face serious financial consequences if you fall behind on your taxes. As you'll see, some of these issues might harm your credit in an indirect way.
You'll End Up Paying More
Like most other bills, your taxes have a due date. That due date is generally April 15. If you owe an outstanding balance to the federal government and you can't pay it by this deadline, you may be charged a penalty for not paying all of your taxes on time. To make matters worse, the IRS will typically charge you interest on top of your unpaid taxes and penalty fees.
Paying extra money in penalties and interest because you sent in your tax payment late could make it more challenging to keep up with the rest of your bills. If this happens, and if you fall behind on any credit obligations as a result, your late tax payment could indirectly have a negative impact upon your credit. Payment history is the most important factor in your credit score, counting for about 35% of your score, so late credit payments reported by your creditors can damage your credit quickly.
Of course, late payments aren't the only risk to your credit when you become overextended financially. High credit card balances may also be problematic if they cause your balance-to-limit ratio, also known as credit utilization ratio, to increase.
Your credit utilization ratio typically counts for about 30% of your credit score, so a high utilization rate of 30% or more can negatively affect your credit, even if you make your monthly payments on time. High utilization can be a sign to creditors that you're using too much credit and may be more likely to make late payments.
You Might Have Trouble Qualifying for a Loan
Your credit reports don't show tax liens anymore, but that doesn't mean a tax lien can't cause you problems if you apply for a loan. In particular, when you apply for a mortgage, your lender may perform a public records search to find out whether you have any outstanding judgments or tax liens filed against you.
Your best bet is to pay off your tax lien before you apply for a mortgage. Can't afford to pay the lien in full? Setting up a payment plan with the IRS might be enough to satisfy some lenders, if you can prove that you've made a sufficient number of consecutive payments.
Keep in mind, if you set up a payment plan to pay your taxes, your lender will add your monthly payment to the IRS into your debt-to-income calculations. This means those lien payments could reduce the size of the home loan you qualify to receive.
Don't Ignore the Problem
If you have a tax bill that you can't afford to pay, ignoring the problem isn't the answer. In fact, as penalties and interest continue to climb, pretending like your tax bill doesn't exist will only make your situation worse.
Instead, consider reaching out to the IRS to discuss payment plans and other tax relief options. If your credit is in decent shape, you might even be able to qualify for a personal loan to cover your tax bill at a lower interest rate than the IRS would charge.
Remember, even if unpaid taxes don't hurt your credit, they can still make your life a lot more stressful. Addressing your tax issues head on, either on your own or with the help of a reputable tax professional, is your best move.
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