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What happens to your credit when you don't pay your taxes?

Missing the tax deadline is like missing a car payment -- and your credit scores could get smacked.

By Money Staff Apr 11, 2014 2:00PM

This post comes from Paul Sisolak at partner site GoBankingRates.com.


GoBankingRates.com on MSN MoneyLook up the word "deadline" in your online dictionary of choice, and it should be accompanied by an IRS logo. That's because the Internal Revenue Service is dead serious about its tax filing deadline of April 15.


Tax form © Brian Hagiwara/Brand X/CorbisMiss the tax deadline and the consequences can be even more serious. Failing to pay your taxes can result in the IRS and assorted parties going to great lengths to get their money. But how does it affect other areas of life, like your credit score?


The truth is that unpaid taxes are an outstanding debt no different than a missed car payment or a bout with bankruptcy, and they can take your FICO digits down quite a few notches. If you're running late on filing your taxes, do it in time, or the consequences could pose a harmful impact to your credit.


You didn't pay your taxes: What happens first?

Mandi Woodruff of Yahoo! Finance recently detailed several adverse tax scenarios that can damage your credit. Say you missed the filing deadline. Say you filed your returns but haven't paid the bill. But worse, let's say you've done neither and ignored the existence of your taxes entirely.


According to Woodruff, the IRS will impose a number of ungainly penalties. First comes:

  • A failure-to-file fee, which starts at 5 percent of your tax bill and can reach as high as 25 percent.
  • If you filed an extension, you'll still get hit with 0.05 percent late filing fee, as well as a 3 percent daily compounding interest.
  • After 60 days, you’ll get charged $135 or 100 percent of the taxes owed (whichever amount is smaller).

The costs for failing to file and pay can be astronomical. "You’d be surprised how quickly those fees can add up," Woodruff wrote.


Here's what the IRS will do immediately

"'Ignore them and they'll go away' is great advice for some of life’s annoyances. Unfortunately, it doesn’t apply to taxes," wrote Martha C. White of Time.


Translated: Ignore your taxes and the IRS will come after you.


The most common tactic Internal Revenue officials can carry out is place a lien on your assets. If your tax debt remains unpaid, the IRS has the right to file a federal tax lien motion in court, and can lay claim to your personal property, like your car, your house or any combination of things worth the value of taxes you owe.


A tax lien is usually a last resort from the IRS to get you to pay up. "Generally, the IRS won't hit you with a lien unless you’re delinquent for years, but a lien is a huge headache," White noted.


The biggest migraine inducer is that the federal lien filing is public record. Because of this, the IRS will report it to the three credit bureaus — Experian, Equifax and TransUnion — agencies that determine your FICO score.


Because of this, your score will drop.


The IRS could also garnish your wages from a variety of sources, like your checking or savings account, or your retirement benefits.


The impact of tax debt on your credit

By how much? According to White, your credit score could drop anywhere from 100 to 150 points.


If you've already been struggling with a poor-to-average credit score (or worse, no credit), a 100-point drop can be disastrous. Even people with exemplary credit — in the mid-700 range and above — can still feel the impact that a 3-digit drop on their credit score can make.


The credit bureaus will eventually forgive your debts, even if they remain unpaid. But not a tax lien, White said. "That lien will stay on your report indefinitely as long as it's outstanding," she wrote. "If you settle with the IRS for less than what you owe, it will stay on your credit report for seven years."

And that's seven years of bad luck that nobody wants. Fear not: Before any of this happens, there are some steps you can take to resolve your unpaid tax woes.


How to climb out of tax debt

Regardless of your options, you still owe the IRS money and need to pay it back in some way, credit score or no credit score. What are some steps you can take?


You won't likely be able to request a tax extension if you’ve missed the tax deadline and payment altogether. But, you can request to arrange an installment payment plan with the IRS. An application fee of $52 or $104 applies here (depending on income), and you'll need to pay interest, but at least it's better than a lien.


When a payment plan isn't feasible, you can also try applying for an "Offer in Compromise" agreement. According to Woodruff, an OIC is a specialized program that settles your tax debt for a reduced amount.


And if the OIC doesn't work, you might be able to prove an undue financial hardship to stave off the IRS from imposing a lien on you, Woodruff said. You can do this by calling the phone number provided on your IRS letters.


Be proactive. If you don’t think you'll be able to meet the filing deadline, or that you won't be able to pay your taxes in full, get in touch with the IRS now. Ask for an extension, tell them your problem, arrange for a payment plan. Do what it takes to avoid going into debt. Should the worst happen, follow these tips to get out of debt and slowly heal your credit.


In the meantime, always make sure to be a responsible borrower in every other line of credit you might have, like a mortgage, car payment or credit card. Even the worst unpaid tax scenario can be offset on your credit report by timely, revolving debt repayment of your other expenses.


More from GoBankingRates.com

VIDEO ON MSN MONEY

2Comments
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It is so sad that we, as a nation, are so dependent on credit that we are worried that not paying your taxes can damage our credit score.
Apr 14, 2014 4:02PM
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Don't pay your taxes and see how that works for you.
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