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How Paying Your Taxes Affects Your Credit

Bethy Hardeman

First of all, the important reminder: Tax Day 2014 is April 15.

OK, now that's out of the way, we're here to talk about how paying -- or not paying -- your taxes can affect your credit. First off, if you pay your taxes on time and with a debit card or check -- not a credit card -- your payment won't affect your credit. But other payment strategies or a lack of payment can have an impact on your credit.

Paying taxes with a credit card

First off, it's important to know that you can pay your taxes with a credit card. Paying with a check or debit card (read:not borrowed money) is sometimes the better option, but the Internal Revenue Service will accept a credit card payment.

Keep in mind that while the IRS doesn't charge a fee, the processing companies it uses for these payments typically charge a convenience fee of anywhere from 1.89 percent to 2.49 percent of the amount you're paying. So if you owe a large amount to the IRS, you may be stuck with a hefty fee on top of the taxes you already owe.

Once you've decided to pay your taxes with a credit card, it's important to know how it could affect your credit and your wallet:

-- Higher credit card utilization rate. Your new credit card balance could really boost the percentage of credit you're using. If this percentage gets too high, it can negatively affect your credit score. Know how much of your available credit you're using, and start paying down your balance as soon as possible.

-- Interest rate payments. If you're unable to pay off your statement balance at the end of the month, you may start racking up interest payments on the tax payment you just made, essentially costing you more than just your initial tax payment (plus the processing fees). This is another great reason to start tackling your credit card debt repayment as soon as possible.

Paying taxes with a personal loan

If your tax bill is larger than you anticipated, you may decide to apply for a personal loan to pay off your taxes. If you do, remember the process of finding and selecting the right loan can take some time, so don't do this at the last minute. Here's how your credit may be affected by your new loan:

-- Hard credit inquiry. The loan application will count as a new hard inquiry on your credit. One inquiry will have minimal impact on your credit score, but several hard inquiries during a short period of time can sometimes lead lenders to believe you're desperate for access to credit. Make sure you understand which loans you're likely to get approved for before applying.

-- New debt. Your new loan amount will be added to your existing debt. Your total debt amount is a significant factor of your credit. Plus, this debt will contribute to your debt-to-income ratio, which is assessed with new credit applications.

-- Monthly payments. Here's some good news: If you make monthly payments on time for your new loan, it can help build your credit. But if you start missing payments, you could hurt your credit.

What happens to my credit if I don't pay my taxes?

Before you get to this point, know that the IRS is willing to work with you. If you just need a little more time to come up with your payment, you can ask for a 120-day extension. (You must file for an extension by April 17.) If you need longer, you can inquire about installment payment plans.

If you don't pay your taxes, it could spell serious trouble for your credit. If your debt remains unpaid, the IRS can choose to file a federal tax lien in court to try to ensure repayment. A tax lien is a legal claim to your property, like your house. Once a tax lien hits your credit report, it could drop your credit score by 100 points or more. This may put you into a lower credit score range and make it difficult for you to get approved for new credit.

A tax lien will remain on your credit report until it's paid in full. The IRS may still be willing to work out a payment plan with you, but the lien will remain until your tax debt is paid off, and it generally cannot be discharged in bankruptcy.

The bottom line: Before you decide how to pay your taxes, make sure you understand the implications your choice could have on your credit and your financial future.

Bethy Hardeman is the consumer advocate for creditkarma.com, a free credit monitoring website that helps more than 22 million people access their credit score for free.

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