Each year, the bulk of people who file a tax return wind up with money back from the IRS. But not everyone gets a refund, and if you're in the minority of people who end up owing money, you may not have the savings on hand to cover it.
The Federal Reserve Board estimates that 39% of Americans don't have ample savings to cover an unplanned $400 expense. If you're in that camp, and you wind up with a tax bill on your hands this year, you may be tempted to whip out a credit card to cover that debt, and then pay your balance off over time.
In fact, 21% of Americans say that they if they owed the IRS money, they'd use a credit card to fulfill that obligation, according to tax prep company Jackson Hewitt. But that could end up being a very costly mistake.
The importance of paying your tax bill on time
The tax-filing deadline this year is April 15, and that's also the deadline to pay the IRS what you owe on your 2019 return. Fail to come up with that money, and you'll immediately face penalties and interest that add to your costs.
But what if you don't have the money to pay your tax bill on time? Is a credit card the answer?
Actually, it's not, and for several reasons. First, you'll automatically be charged a fee of around 2% of your tax bill to use a credit card to pay it. If you owe the IRS $2,000, that's a $40 charge right off the bat.
Secondly, if you have to carry that balance, you'll be subject to whatever interest rate your credit card company charges. And chances are, it will far exceed the interest the IRS will charge you for being late.
Furthermore, carrying a credit card balance could actually drag your credit score down, making it more difficult for you to borrow money affordably when you need to. That's because a big component of your score is utilization, or the extent to which you use your revolving credit. A utilization rate above 30% can hurt your credit score, but if you're looking at a total line of credit of $4,000, and you charge a $2,000 tax bill on a credit card, you're suddenly at 50% utilization overnight, which really isn't good.
A better way to tackle a tax bill
Rather than rely on a credit card to pay your tax debt, you're better off getting on an IRS installment plan. If you're able to pay off your tax bill in 120 days or less, you won't incur a setup fee for one of these plans. If you're looking at a longer repayment period, you'll be charged $31 to apply online for a direct debit plan that automatically deducts payments from your checking account each month until your debt is paid off. You'll still pay interest on your tax obligation under an installment plan, but again, the rate you're looking at will generally be considerably less than what a credit card will charge you.
As Mark Steber, chief tax officer at Jackson Hewitt, puts it, "Paying off tax bills can often be intimidating, but IRS installment agreements can be easy and have lower interest rates compared to other financing options."
Of course, being in a position where you owe money on your taxes isn't great -- especially if you owe a lot. If that's the case, check your tax withholding and make adjustments to avoid a repeat during next year's tax season. And if you don't want to change your withholding and shrink your paychecks, be sure to pad your savings account so that if you do get stuck with another large tax bill, you won't even have to think about resorting to a credit card to cover it.