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If you have to pay taxes this year, you may be wondering how that could impact your credit. Tax bills do not affect your credit scores directly, but if you use credit to pay your taxes or fail to pay your taxes in full, your credit score can be affected indirectly, and your eligibility to borrow money can suffer in other ways.
Read on to find how your tax payment could play a role in your credit.
What Happens to Your Credit When You Don't Pay Taxes?
Credit scores are based on information in the credit reports compiled at the national credit bureaus (Experian, TransUnion and Equifax). These reports reflect your history of borrowing and repaying loans and also note certain legal proceedings, such as bankruptcy filings and foreclosures. Your credit reports don't track tax bills or payments, so your record of paying taxes on time, or failing to do so, does not factor into the calculation of your credit score.
Failure to pay your income tax can lead to a federal tax lien against your property. A lien entitles the IRS to take whatever unpaid taxes you owe (plus penalties and interest) from the proceeds of the sale of your property.
Tax liens haven't appeared on credit reports since 2018, so they cannot lower your credit scores, but tax liens can still damage your credit: Lenders can discover tax liens through public records searches when considering applications for mortgages or other loans. Some lenders may consider a tax lien grounds for denying your application.
How Paying Your Taxes Affects Credit Score
If you pay your taxes with a credit card or personal loan, those transactions will be recorded in your credit reports, and they will be reflected in your credit scores.
When You Pay Taxes With a Credit Card
The IRS authorizes a number of private third-party companies to process tax payments by credit card. When you pay this way, the amount of your payment, plus a fee of nearly 2%, will be added to the balance of the credit card(s) you use to make the payment.
Paying by credit card can be convenient, but keep in mind that you'll be paying interest at your credit card's standard rate on the payment unless you pay off the balance in full within one billing cycle. Charges can add up quickly if you're not able to pay down the balance right away. That can lead to excess credit card debt that could eventually hurt your credit score.
Adding to the balance of a credit card increases your credit utilization ratio—the card's outstanding balance relative to the borrowing limit. Utilization greater than 30%, on a single card or on all of your credit card accounts combined, can hurt your credit score.
Depending on the size of your tax bill and the borrowing limits on your credit cards, you may want to consider spreading your payment across multiple cards to avoid pushing utilization on any single card over 30%. If your tax payment causes your total utilization to exceed 30%, there's not much you can do to avoid a credit score reduction, other than pay down your balance(s) as quickly as possible to allow your score to recover.
When You Pay Taxes With a Personal Loan
Paying your taxes with a personal loan can be a more affordable option than using a credit card, since interest rates on personal loans are sometimes more affordable than credit card rates. With a set number of fixed payments, over a repayment period of two to five years, personal loans are predictable and can be easier to budget for than credit card bills, with their indefinite payment amounts.
Using a personal loan to pay taxes requires some advance planning. You'll need to calculate your tax obligation early enough to give yourself time to apply for and receive the loan amount before your tax payment deadline. You may be able to qualify for a personal loan within a few days, but it's wise to apply to multiple lenders to shop around for the best interest rate deal.
A personal loan and your record of making payments on it will appear as activity on your credit reports, and will therefore have an impact on your credit score. The credit checks associated with applying for a personal loan, known as hard inquiries, will cause a slight reduction in your credit score, but your score should rebound within a few months as long as you keep up with all your debt payments.
Once your credit score rebounds, it may even get a little lift if the personal loan adds variety to your credit mix, or the variety of credit accounts you hold. Credit scoring systems tend to reward individuals with multiple credit accounts and loans of different types, which is seen as evidence of good credit management skills.
When You Pay Taxes With IRS Installment Agreements
If you don't want to use credit cards or a loan to cover your tax payment, you might want to consider one of the payment programs available from the IRS. The IRS offers a 120-day payment plan and longer-term plans for a negotiable number of months, depending on the amount you owe and how large you want to make the monthly payments.
Interest rates on these plans are relatively low (3%), but the long-term plans come with significant setup fees, and both long- and short-term plans charge you late penalties of 0.25% of your balance each month until you meet your tax obligation.
IRS payment plans are not considered loans. They are not recorded in your credit reports and don't affect your credit scores.
The Bottom Line
While paying taxes has no direct bearing on your credit scores, using credit to cover your tax payment can affect your credit indirectly, and failure to pay your taxes not only gets you in trouble with the IRS, it also jeopardizes your ability to get credit.