You’re probably aware of some of the consequences of not paying your taxes on time, like penalty fees and the accumulation of interest obligations. What you may not be aware of is that a failure to pay what you owe the IRS can actually have a serious impact on your credit score. This will cause you certain hassles not just in dealing with the tax authorities but also when you’re trying to secure any type of financing.
What is a Credit Score?
Your credit score is a number that’s generated by credit reporting agencies that look at your payment history, debt-to-income ratio and other relevant metrics, and it aims to gauge how good a credit risk you are. When you apply for a mortgage, car loan or virtually any other type of financing, the lender will look at your credit score and base the total amount offered and the interest rate on this information. Lackluster credit could compromise your ability to access the money you seek, and you could wind up having to pay extra in interest on those loans that you are approved for.
If you owe a significant amount of unpaid taxes, the IRS may put a tax lien on you. This means that it might pursue seizing your assets, like your home or car, in an effort to collect what’s due. Even if you don’t have any valuable property worth speaking of, a tax lien will show up on your credit report, and it will count strongly against you in the eyes of lending institutions.
The government tends not to issue such liens unless the amount owed exceeds $10,000. By paying down your balance to below this figure, you might be able to get a lien removed. It will still appear for up to 10 years on your credit report, but you can file an Application for Withdrawal, which, if successful, will excise the lien from your report as though it had never existed in the first place.
How to Repay Your Taxes
If you can pay the taxes you owe but not right away, then it might be beneficial to enter into a repayment agreement for the sum still outstanding. An installment agreement to pay a set amount each month until the balance is paid up doesn’t count as a loan and shouldn’t affect your credit unless you default on your responsibilities under the agreement. A further advantage of making an agreement with the IRS is that it may forestall the filing of a tax lien against you.
If you’d rather discharge your tax liabilities in one shot rather than over time, then you may be able to essentially borrow the amount you owe, hand it over to the authorities and then make payments to the lender. This is basically what people are doing when they use their credit cards to pay their tax bills.
The downside to this path is that you’ll have to pay a lot extra in interest to your card issuer until you can reduce your balance to what it was before. Furthermore, the new charges on your card will affect your credit utilization ratio, which is a measure of the fraction of credit you’re currently using as compared to the total credit you have available to you. A too-high credit utilization figure will make lenders perceive you unfavorably. However, this problem will diminish going forward as your ongoing payments will contribute to improving this figure every month.
You might also find it worthwhile to obtain a personal loan as a means of raising the money to pay your outstanding tax obligations. Whatever interest rate applies to such a loan will probably be much more favorable than what your credit card charges. You’ll want to already have fairly good credit for this to be a reasonable option. Otherwise, lenders may refuse to loan you the money.
It’s your duty as a citizen to file and pay your taxes in a timely way, and being unable or unwilling to do so could have lingering effects on your creditworthiness and financial well-being. Fortunately, there are several strategies you can employ if you should happen to fall behind. Restore your good credit and your good name by resolving this embarrassing situation as soon as possible.
Maricel Tabalba is a freelance contributor for Credit.com who is interested in writing about personal finance advice for Millennials and college students. She earned her Bachelor of Arts in English with a minor in Communication from the University of Illinois at Chicago.