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Let’s say that you find yourself with some tax debt this year. It’s less than ideal—if you’re scrambling to pay off your tax debt, it might have a huge impact on your financials. But does tax debt affect your credit score? And does an IRS collection go on your credit report?
The IRS doesn’t report directly to the credit bureaus. And a tax lien won’t show up on your credit report either. But that doesn’t mean taxes won’t impact your credit score. Read on to find out more about how federal taxes and credit can be related.
The IRS doesn’t report information about the taxes you owe, when or how you pay them or whether you’re in collections to the credit bureaus. In fact, the Taxpayer Bill of Rights includes a right to privacy and confidentiality. That means that in many situations, your tax information is not public knowledge.
What does this mean?
Prior to April 2018, federal tax debt could show up on your credit report via another path. If the IRS files a tax lien against you for taxes owed, the information becomes public record. That’s true of most liens.
Credit reports used to include information about liens. In April 2018, the credit reporting agencies modified policies on how certain public records, including liens, were dealt with. That included removing all tax liens from credit reports.
What does this mean?
Just because taxes don’t appear on your credit report doesn’t mean they won’t have an impact on your credit score. If you’re behind on taxes or dealing with paying off a large tax bill, that could have an impact on your overall finances. In turn, that could negatively impact your credit score. Here are a few ways this can happen:
In the worst-case scenario, you might make payments on tax debt instead of payments owed on a mortgage, car loan or other debt. If you do this for several months, you could risk serious issues like foreclosures or repossessions. Even if you only do it for a month or two, you can end up with late payments reported on your credit report. All those things are bad for your score.
In less severe cases, you might be able to make tax payments while also making timely payments on your other debts. But perhaps you’re not paying down balances on those debts quickly because you’re prioritizing your tax debt. That can lead to a higher credit utilization ratio for longer, which can impact your credit score.
If you aren’t starting with a large balance on your credit card accounts, you might think about using them to pay down your tax bill. That’s one way to remove the stress of a potential tax lien. For many people, the interest expense of paying off some credit card debt is preferable to facing consequences from the IRS.
But this option does impact your credit score. If you max out or drive up your credit card balances to pay off tax debt, you increase your credit utilization ratio. Credit utilization is about 30% responsible for your credit score, so that can make for a big impact!
Instead of revolving credit, you might use an installment loan to pay off some tax debt. Whether you’re taking out an unsecured personal loan or a home equity loan, this new debt will have at least some impact on your credit. First, there’s the hard inquiry that may be required to evaluate you for the loan. Hard inquiries can negatively impact your credit score a bit.
Then there’s the fact that you have a new account on your credit score. That can also cause a temporary drop in your score if it changes the overall age of your credit.
Tax debt doesn’t magically go away, and the impact to your life and finances can get bigger the longer you ignore the issue. If you owe taxes, make a plan to pay them as soon as you can.
Does filing taxes late affect your credit score? Not directly, but it can lead to all the issues discussed above. If you know you’ll owe taxes, don’t avoid filing because you can’t pay. Interest on tax debt is often less than the fines for not filing your return on time. You can also reach out to the IRS to set up installment plans or other payment arrangements on large tax bills.
It’s also a good idea to be familiar with how your other debts might impact your taxes. For example, if a creditor forgives your debt and sends you a 1099C cancellation of debt, you may need to pay taxes on that amount.
Learning how to do your taxes yourself and getting a head start on the process every year can be a good idea to get ahead of tax debt. When in doubt, consider consulting a tax or financial professional to help you come up with the right plan for you.
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