What Can I Do to Keep Taxes From Harming My Credit Score?
Owing the IRS a big tax bill come April 15 doesn’t automatically affect your credit score, but when (on time or late) and how you choose to pay your taxes (like using your credit card) can. Unpaid taxes especially can take a toll on your credit if they go unpaid long enough.
Here are some of the ways you can cover your tax bill, from IRS installment payments to IRS bill pay, and how they may impact your credit.
Payment Option 1: Personal Loans
If you apply for a personal loan to cover a larger-than-anticipated tax bill, the loan amount and your monthly payment record will be noted in your credit reports. And the loan application itself will count as an inquiry into your credit and this will lower your credit score a little bit, though the drop will be temporary.
If you need to apply for a personal loan to cover a tax bill, you can begin by getting a free look at your credit strengths and weaknesses using Credit.com’s free snapshot of your credit report. Minimize loan applications by finding out a lender’s minimum credit score requirements in advance. Choose a lender with credit requirements that match your credit score.
Payment Option 2: Credit Cards
Charging a big tax bill is certainly an option for consumers who have credit cards with roomy credit lines. But there can be consequences for your credit score if you’re already using a large amount of your available credit. Charging a credit card near its limit can hurt your credit utilization ratio, and that could keep you from qualifying for additional credit like a mortgage or auto loan. Your credit utilization takes the total amount of debt you have on all of your revolving credit accounts (i.e. credit cards) and compares it to your accounts’ limits. And this important measurement makes up about 30% of your credit score.
Payment Option 3: Installment Agreements
Agreeing to pay a tax bill by an installment agreement with the IRS doesn’t affect your credit since installment agreements are not reported to the credit reporting agencies, which means it won’t affect your credit scores like paying over time with a credit card would.
The IRS offers a few payment options for taxpayers who can’t pay their taxes all at once, including online payment agreements.
If You Can’t Pay: A Tax Lien or Bankruptcy
Failing or neglecting to pay your tax bill could affect your credit, especially if your tax bill is $10,000 or more, the threshold at which the IRS generally issues a tax lien against citizens.
A tax lien is considered a serious negative item and could remain on your credit report for seven years after the tax liability is resolved, unless you take steps to have it withdrawn.
In 2011, the IRS made some changes to its tax lien policies, making it easier for taxpayers to get lien withdrawals after paying their tax bills and in most cases withdrawing tax liens when a taxpayer enters into a Direct Debit Installment Agreement.
If you are simply unable to pay your taxes through any of the methods mentioned above, there is the option of filing for bankruptcy, but that would be a significant setback for your credit, as it would remain on your credit reports for seven years for a Chapter 13 case, or 10 years for a Chapter 7 case. Still, if you are struggling under a staggering amount of debt, be it taxes or personal, filing bankruptcy can be a helpful last resort.
Whatever strategy you choose to resolve your tax debt, it’s a good idea get your free credit reports and free credit scores to make sure there are no unexpected surprises.