As tax season moves into full swing, you may be thinking of the best way to pay the taxes you owe.
The IRS strongly encourages taxpayers to make their payments online. One way to do that is by using your credit card. Aside from being a quick way to make a payment, a credit card could also benefit from earning rewards. However, if a credit card payment is made without a repayment strategy, it could cost more in interest and possibly affect your credit score.
It’s important to understand the pros and cons of using a credit card to pay your taxes so that you can make the best decision for how to handle your payment this year.
Advantages of paying taxes with a credit card
If you are facing a tax bill that you aren’t able to pay in full using a checking or savings account, using a credit card could be a helpful alternative. Not to mention, there are some real advantages to using a credit card instead of tapping into your cash funds.
Earn a welcome bonus
Many card issuers offer a welcome bonus if you spend a certain amount on your card within a specific time frame. This bonus can come in the form of a big points or miles yield or a statement credit for your account. Paying your taxes on your credit card could be just the thing to help you meet your spending goal to earn a welcome bonus.
If you’re making your payment with a rewards credit card, you stand to add valuable points, miles or cash back to your account. To maximize the rewards you earn on your tax payment, you need to use a card that offers high rewards for general purchases.
If you’re looking at a high tax bill, you may not be able to make your tax payments on one card. However, you do have the option to split your payments. All three official IRS processors allow you to make two separate card payments per year. So you can put part of your tax bill on one card and the rest on a different card. This option could help you keep from maxing out your credit cards or depleting your cash funds. It also allows you to spread your rewards earning potential across two different cards.
Give yourself time
Paying by credit card is a way to spread the financial burden of paying your taxes over a longer period of time. You can pay off your taxes with credit and then make your card payments each month until you pay off your credit card. Ideally, you’d be able to pay off your balance before the next billing cycle to avoid having to deal with added interest.
However you choose to approach paying off your credit card balance, you are afforded more time when you pay this way. As long as you meet your minimum payments per month, your credit card account should remain in good standing.
Drawbacks of paying taxes with a credit card
While using a credit card to pay off your taxes can be very helpful, it is not always recommended. Credit card processing fees add to your tax bill. And if you don’t pay off your balance in full, so does credit card interest.
The IRS doesn’t process credit card payments on its own. Instead, it goes through third-party processors to handle credit card transactions. For this reason, you will have to pay a processing fee to use a debit or a credit card to pay your taxes.
Processing fees for credit cards can be up to 1.99 percent of your tax bill and debit card fees can be as high as $3.95 per payment. Working through a tax service will also result in fees for credit card payments, sometimes up to 2.5 percent of your tax bill. You may also have to deal with additional convenience fees added to your payment. These fees are added on a case-by-case basis, depending on the processor.
If you plan to pay off your tax payment in full with your next monthly credit card payment, interest shouldn’t be an issue for you. However, if you plan to carry a balance when you charge your tax payment, using your credit card is going to cost you a lot more in the long term. The average credit card interest rate is currently approximately 16 percent on balances you carry.
That could increase a $1,500 tax payment to a much higher amount owed pretty quickly. If you know you will carry a balance for your tax payment, it’s best to use a card that offers a 0 percent APR period to give yourself more time to pay down your balance.
Damage to your credit score
Using your credit card to make large purchases increases your credit utilization, which has the potential to lower your credit score. That’s because healthy credit utilization is actually pretty low. The ideal range for credit utilization is no more than 10 percent to 30 percent of your total available credit.
For example, if you have a total available credit of $10,000 and use your credit card to make a $5,000 tax payment, you are using 50 percent of your available credit—well over the recommended amount.
Fortunately, any decrease you see in your score because of high credit utilization can be addressed by simply paying down or off the balance on your credit card.
To quickly determine your current ratio, check out Bankrate’s credit utilization ratio calculator.
Accruing debt on your credit card is a slippery slope. If you’ve put a large tax payment on your credit card and you aren’t able to pay it off right away, you may be setting yourself up to default on your account. Interest on your balance will grow each month, raising your total balance and your minimum payment. If you’re not prepared to handle the increase, you may end up missing payments or making late payments.
Before you put any large payment on your credit card, it’s important to have a repayment strategy. You can use a repayment calculator to help you see how long it will take you to pay off your payment and how much you will need to pay each month to do so.
Using a credit card to make your tax payment can offer you the benefit of more time to pay and the possibility of rewards. However, it will require a clear repayment strategy in order to make paying this way less costly in the long run. It’s important to make sure that using your credit is going to give you sufficient value to be worth making the charges. If that’s not the case, the IRS offers short- and long-term payment plans if you don’t have the cash available to pay your taxes all at once.