If you don’t have enough money to cover your tax bill come April 15th, don’t freak out. Late payments to the IRS only affect your credit score if you don’t address the issue within 30 days or more. The best thing to do is to speak with the IRS and negotiate an affordable payment option or to request an extension. Unfortunately, if you leave tax bills unpaid or take on more credit or loan debt to cover your unpaid taxes, your credit score could be negatively affected.
Read on to find out how your tax bills might affect your credit score, and how you can protect your credit from any negative consequences this tax season.
Paying Taxes with a Credit Card
Although being able to make your tax payments on time and avoiding any late payment fees is obviously important, taking on more credit debt is always a risk, especially if you’re not able to make your monthly payments. Paying your taxes with your credit card could raise your credit utilization, which counts for 15% of your FICO credit score. Worse, stretching your credit limit to cover tax debt could signal risky behavior to lenders and the credit bureaus alike, especially if you have a record of late or minimum payments in the last 6 months.
One way to avoid the additional risks of paying your taxes with a credit card is to request a payment plan with the IRS. A payment plan is an agreement with the IRS to pay your tax dues within a certain time period, usually over the course of four months or more. However, you should only take this option if you know that you can make all of your payments on-time and in full! Missing a monthly payment to the IRS could result in penalties and fees which could further worsen your debt and credit rating.
Paying Taxes with a Personal Loan
Shopping around and applying for personal loans may help you cover your tax debt, but each new application requires a credit inquiry by the loan company, which may result in your credit score dropping. To protect your credit and prevent multiple inquiries from dragging down your score, keep your application period to a 10-day period.
If you take out a personal loan to cover your taxes and default on the loan, you face late payment fees as well as the possibility of your lender taking legal action. Lawyers are expensive for both your time and money, so the best thing to do is avoid defaulting on your loan and making all your payments on time. Or, better yet, avoid the risks of taking out a personal loan altogether.
Paying Your Taxes (Very) Late
If you have an unpaid tax debt of $10,000 or more, you have 30 days to make a payment before the IRS considers filing a notice of federal tax lien with the credit bureaus. A tax lien could result in a 100 point drop in your score and could stay on your credit report for seven years.
The IRS will send you a written notice before imposing a tax lien, in which case you should begin negotiating with them immediately to find an affordable alternative, such as their Fresh Start program. If you already have a tax lien on your hands, start paying off that debt right away to avoid legal fees and further damage to your score. Better yet, if you pay off your debt in full, you could apply to get the tax lien removed from your credit reports and improve your score.
Another way taxes can affect your credit score (indirectly), is if your tax debt forces you into bankruptcy. Filing bankruptcy to get rid of your other debts may allow you to pay your taxes and avoid legal action by the IRS, or it might help you discharge some or all of your tax debt.
Unfortunately, filing bankruptcy will also damage your credit score, making it harder and more expensive for you to secure auto loans, mortgages, student loans and credit cards in the future. A Chapter 13 bankruptcy will stay on your credit reports and continue to affect your credit score for 7 years. A Chapter 10 bankruptcy stays on your reports for 10 years.
All in all, the best way to make sure that your tax debt does not affect your credit score is to pay off that debt in a timely and efficient manner. Whether you’re considering requesting a payment plan or jumping into the Fresh Start program after receiving a notice of tax lien, you should talk to the IRS to figure out how to pay your debts and protect your credit.