Smart TaxesSmart Taxes

Don't use credit cards to pay taxes

Using a credit card to pay for taxes may be convenient, but there are extraordinary costs.

By TheStreet Staff Mar 29, 2010 12:35PM

TheStreetBy Bill Hardekopf, TheStreet

 

The tax deadline is more than two weeks away and consumers will soon be bombarded with messages encouraging them to pay with a credit card.

 

While this may sound appealing to consumers struggling to find ways to pay taxes in this turbulent economy, it should be avoided at all costs.

 

The Internal Revenue Service and some credit card issuers promote the benefits of paying taxes with a credit card. Payment with a credit card is easy and can be made via phone or online. It delays the pain of payment for another month. Consumers can even earn reward points on some cards.

 

But credit card payments of taxes are actually made to third-party providers, which are contracted by the Internal Revenue Service. Processors charge from 1.95% (payUSAtax.com) to 3.93% (FileYourTaxes.com). Most third-party providers charge a 2.35% fee for processing a tax credit card payment, making this a costly convenience.

 

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The 2.35% processing fee adds $117.50 to a $5,000 tax bill. If you don't immediately pay off the credit card bill, interest charges from your credit card will add even greater penalties. Since interest rates have increased significantly over the past year, this makes paying your taxes by credit card even more costly.

 

Along with this significant processing fee and possible interest penalties, consumers should also consider other factors:

 

1. Know your credit limit before you charge your taxes. If you are anywhere close to your limit, this is not an option for you. Issuers are now sensitive about debt loads and customers who are close to their limit. This sends a warning to issuers that you are a risk for default. If this payment puts you close to your credit limit, it can raise your credit utilization score, an important factor in your credit score. This can result in a lower credit score and higher interest rates from your lenders.

 

2. Verify that the tax payment will be treated as a purchase and not a cash advance. Cash advances come with a high interest rate and typically a 3% cash advance fee.

 

3. Be careful how you provide your credit card number. The IRS warns filers not to write the credit card number on the return and not to mail in the credit card.

 

4. If you can't afford to pay your taxes now, there are less expensive options than a credit card loan. An installment plan with the IRS is one possibility; the interest rate is currently 4% percent for underpayments. Another option is a personal loan with a bank or credit union.

 

5. Obtaining reward points for using your credit card is not a good reason to charge your income taxes. Several years ago, generous credit card reward programs offered 3% to 5% cash back, and some cardholders were able to make a little money by paying their taxes with a reward card. Since the typical reward card now offers 1% back for cash, points or miles, the 2.35% processing fee will cost more than the rewards you can earn.

 

 It is much smarter to use your tax refund to pay off your credit card balance. Paying down your credit card debt will improve your debt utilization ratio. This will, in turn, help your credit score and that could result in lower interest rates for other loans. That can improve your financial stability.

 

Bill Hardekopf, a contributor to TheStreet, is the chief executive officer of LowCards.com, which compares and rates more than 1,000 credit cards. He is the co-author of "The Credit Card Guidebook."

 

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