Did your 2012 tax return come with an unwelcome surprise? Ours certainly did. Even though we were having the proper amount of taxes withheld from our paychecks, our frugal spending habits in 2012 resulted in a $2500 tax bill that caught us totally off guard.
In the past, I would have paid off the IRS tax bill with a credit card. This year, I'm squeezing money out of our savings and checking account to cover the bill instead. While paying a tax bill with a credit card is very convenient, it's also an expensive way to pay this debt. Here are a few reasons why.
Processing fees. Since 1997, the IRS has been outsourcing credit card payment services to third party companies. These agencies collect between 1.89% to 2.35% for credit card payments. On a $2500 bill like ours, the processing fee would cost nearly $59. Why I realize this isn't a whole lot of money, it now means that we paying $59 on top of an already high tax bill.
High interest. Paying a credit card off before the first billing cycle is an interest-free way of borrowing money. Unfortunately, the reality of credit card debt is that a bill of this size probably won't get paid off within a month (or even a year) because there's always a new emergency on the horizon. A $2500 bill at 22% interest means that we will pay $500 in interest charges for the year, even if making regular payments of $250 a month.
Impacts your credit score. We've been busy paying down our existing credit card debt and while making great headway, still have a way to go before we're debt free again. Putting the tax bill on plastic would increase what we owe and raise our credit utilization ratio which would lower our credit score. Since we're in the middle of a refinance, a lowered credit score could mean a higher interest rate on the home mortgage.
When it comes to paying taxes, putting the bill on a credit card is not that great of a strategy. If paying cash had not been an option for us, working out a payment plan with the IRS would have been the preferable alternative. While the IRS does charge a one-time setup fee of $105 ($52 if you agree to an auto pay plan), the interest rate with their payment plan is considerably less than what a credit card company would charge. Another advantage, working out a payment plan with the IRS does not affect negatively your credit rating which is a plus for those of us trying to improve our credit scores.
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