The Impact of Taxes on Your Credit

APR 04, 2011

The deadline for filing your tax return is looming and you may be thinking you have enough to worry about, especially if you owe money. Thinking about how your taxes could impact your credit report may be the last thing on your mind, but your tax status can impact your credit score if you owe more than you can immediately pay.

An unpaid debt to the IRS will impact your credit in much the same way as any other unpaid debt – except owing the IRS can have even greater legal repercussions than other types of outstanding debt.

If you find yourself unable to pay your taxes, you have a few options. You can ask the IRS to put you on a payment plan. The total amount you owe and how much you pay on it every month will show up on your credit report like any other installment debt.  The added debt and additional monthly payments could impact your credit score. Still, for many people who owe and aren’t able to pay the total amount up front, a payment plan is the best option.

Another possibility – one we don’t recommend – is to use a credit card to pay your outstanding federal income tax. This is a bad idea on a number of levels, as it still leaves the debt unpaid though it may be settled with the IRS. Most credit cards charge double-digit interest rates, so strategically it’s a disadvantage to the installment plan you could set up with the IRS. What’s more, the rate you get with the IRS will be fixed, whereas your credit card company could change your interest rate for a number of reasons.

Charging your taxes to your credit card will, at least initially, impact your credit report in much the same way the installment plan would. Depending on your card’s credit limit, your debt-to-credit ratio will increase or max out, likely causing your credit score to drop. Ultimately, however, paying your taxes with a credit card could have an even more adverse effect on your credit. Just as the credit card interest rate isn’t fixed, neither is the term. The potential is there for you to pay the debt in the smallest increments possible, which means you could end up still paying for your 2010 taxes in 2015 – or even longer.

Not paying your taxes is not an option. At the very least, the IRS can respond to non-payment by leveling a tax lien against you – something that stays on your credit report for at least seven years.

If you find yourself unable to pay your taxes this year, contact the IRS right away to begin negotiating a payment plan – don’t wait until April 15. Then consult with a tax professional for advice on how to amend your withholdings in 2011 so that you don’t end up in the same situation.