Whether you’re paying taxes for the first time or it’s something you’ve been doing for years, it’s understandable if you’re a little confused about how it affects your credit score. Obviously, both your taxes and your credit are related to your finances, but how do they affect each other?
To give you some peace of mind next tax season, we’ll give you a rundown of what role your taxes play in your credit and what happens when you don’t file your taxes on time.
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Does owing taxes affect your credit score?
Don’t worry, not paying your taxes (or paying them late) won’t have any impact on your credit score. This is because credit reports don’t contain tax payment records, and they haven’t contained tax liens (a penalty for nonpayment) since 2018. 1
Because your credit score is created from the information on your credit report, this means that whether you pay your taxes can’t possibly affect your score.
However, that doesn’t mean you’ll get away with nonpayment. It still has serious consequences for your finances.
Consequences of nonpayment
The consequences of failing to pay your taxes include:
- Tax liens: When you have unpaid taxes that you owe to the government, they may place a “tax lien” on your property. This gives them the right to sell your property to cover your debt.
- Difficulty getting loans: Even though your tax information doesn’t show up on your credit report and doesn’t affect your score, it’s common for lenders (especially mortgage lenders) to review your public records or ask you to show tax return transcripts. If they find that you have a tax lien, they’ll probably reject your loan application.
- Wage garnishment: The IRS is able to take money directly from your paycheck. This is referred to as “garnishing your wages.” Most debt collectors can only garnish your wages if they sue you and get a court judgment against you, but the IRS can do it without taking you to court.
- Penalty fees: If you don’t file your taxes, you may be charged with additional penalty fees and interest, which will be calculated starting on your tax return due date. We’ll explain these penalty fees in more detail below.
How tax penalties work (and how they can hurt your credit)
The Internal Revenue Service (IRS) imposes a failure-to-file penalty that’s equal to 5% of your unpaid taxes for each month that the tax return is late. This penalty is capped at 25% of your unpaid taxes. 2
Fees like this can throw your finances into disarray and make it easier to miss payments on your credit cards and loans. If this happens, it will obviously affect your credit score, and can land you in a deep debt hole that you’ll have trouble climbing back out of.
How does paying taxes affect your credit score?
Paying your taxes doesn’t usually affect your credit. Because your tax records don’t show up on your credit report, paying them on time won’t benefit your credit score any more than paying late will harm it.
However, there’s one circumstance in which your taxes can affect your credit score: you use a credit card or loan to pay them. Any activity on your credit accounts, whether it’s paying something or paying your taxes, will show up on your credit report and affect your credit score.
If you’re looking to build credit, paying your taxes using this method might seem tempting. But is it a good idea? We’ll break down the two options below:
- Paying your taxes with a credit card
- Paying with a personal loan
Paying your taxes with a credit card
Paying your taxes with a credit card is convenient, and it’s a safe option as long as you do it responsibly. Note that your payment processor will probably impose a small fee (in the range of 1.80%–2% of your taxes owed), so you’ll end up paying a little more overall. 3
To protect your finances and credit when you pay, follow these tips:
- Pay off your full credit card balance: After using a credit card to pay your taxes, pay off your full credit card balance rather than just making the minimum payment. Because credit cards typically have high interest rates, delaying means you’ll rack up a lot of interest and your debt will quickly grow. This will hurt your finances and may even affect your credit score if you end up missing payments.
- Use a card with rewards: Remember, you’ll have to pay a small fee when you use a credit card to pay your taxes. If possible, use a card with rewards (such as cash back or airline miles) to offset the fee.
- Use a card with a high credit limit: If your tax burden is particularly heavy, make sure to use a card with a high credit limit. Failing to do so could hurt your credit score by increasing your credit utilization rate, which is the amount of your available credit that you’re using. If all of your cards have low limits, you can ask your card issuer to raise the credit limit on the card you want to use.
Paying your taxes with a personal loan
You can also take out a personal loan to pay your taxes. This is a bigger step than using a credit card you already have, so it’s something you’ll mainly want to do if you’re overstretched financially and you can’t afford to pay upfront (in contrast to paying with a credit card, which many people do to build credit or simply for the convenience).
Taking on debt to pay off your taxes isn’t ideal, but if you’re strapped for cash and can’t pay, a loan is a better option than a credit card for several reasons:
- Lower interest rates: Personal loans usually have interest rates of around 5.28%, in contrast to 14.61% for consumer credit cards. If you can’t pay off your debt right away, you can at least save money on interest with a loan.
- Predictable payments: Personal loans are installment loans, which means you pay them off with fixed monthly payments over a set period (for instance, 2 years). This predictable schedule makes them easier to budget for.
You’ll need to plan ahead if you want to pay your taxes with a personal loan. You need time to shop around for the best deal (i.e., the loan with the lowest interest rate), calculate how much you owe in taxes before you apply, and receive the loan before the tax payment due date.
There are two more things you should bear in mind before using a personal loan to pay your taxes:
- Your credit score will affect your loan terms: One of the major benefits of good credit is better loan options, such as higher loan amounts and lower interest rates. If you have a bad credit score, your loan terms won’t be as good as if you had a good credit score.
- The loan application will likely hurt your credit: Credit applications usually appear on your credit report as hard inquiries, which knock a few points off your credit score. However, your score will recover as you pay off the loan.
Do IRS payment plans affect your credit?
No, enrolling in an IRS payment plan won’t affect your credit. This is because IRS payment plans aren’t considered loans, which means they aren’t reported to the credit bureaus and aren’t factored into your credit score. 4
How IRS payment plans work
For taxpayers who can’t afford to pay their taxes all at once, the IRS offers short-term and long-term payment plans. These payment plans come with interest and penalties, so it’s best to pay off your tax debt as soon as possible to minimize the amount you’re paying overall.
Short-Term Payment Plan vs. Long-Term Payment Plan
|Short-term payment plan||Long-term payment plan
|Repayment period||180 days or less||Flexible repayment period|
|Maximum repayment amount||$100,000 in combined taxes, penalties, and interest||$50,000 in combined taxes, penalties, and interest|
|Setup fee for online applications||None||$31–$130 (fee can be waived if certain conditions are met)|
If you’ve encountered financial hardship and can’t make any payments at all, you may also qualify for an offer in compromise. This could allow you to settle your tax debt for less than the full amount you owe. 5
What happens if you don’t pay your taxes to the IRS?
If you fail to pay your taxes, the IRS will take measures to collect the debt. For example, they may hire a debt collection agency to pursue you for the money you owe. If that happens, you’ll probably start receiving calls and letters from debt collectors.
Debt collection agencies that work with the IRS
There are currently just three debt collection companies that have contracts with the IRS:
Scammers sometimes pose as debt collection agencies, so if you receive a phone call from anyone claiming to be collecting overdue federal taxes, make sure to verify them on the agency’s website. Always pay the IRS directly—never pay the debt collection agency itself.
Wage garnishment and tax liens
As we mentioned at the top of the article, the IRS can also garnish your wages or have a federal tax lien placed on your property (such as your home or financial assets), giving them the right to sell it to cover your debt. 6
These actions won’t directly affect your credit score (in contrast to other debts, which do affect your credit when they’re sent to collections). However, they could indirectly affect your score by making it harder for you to repay your other debts.
How to deal with tax liens
If you have a tax lien, try to resolve it as soon as possible. The best way to deal with a tax lien is to pay your taxes in full—the IRS will then remove the lien within 30 days. 6 Alternatively, explore the alternative repayment options available on the IRS website.