Paying Taxes by Credit Card: Tax Pros, Con Jobs and Hidden Fees

Yes, you can pay your federal income taxes to the IRS by credit card or debit card. Should you do it? Maybe. Here’s how it works:

When you file your tax return through an official IRS e-pay service provider (see list below), you’ll have an option to pay your tax bill by credit card or debit card now or schedule a later date. This payment is processed by the service provider and passed along to the IRS. You will not write your credit card on your tax return. The IRS will never see nor store your credit card information. You will then pay a convenience fee to the service provider.

There are obvious pros and cons to paying your taxes by credit card, most of which are already inherent to using credit cards at all.

Pros of Paying Your Taxes by Credit Card

• Convenience – You can send electronic payment by credit or debt whether you e-file or paper file. This saves you from writing out and mailing a paper check (does anyone still do this?).
• Deferred Payment – It’s a bit late now, but if you’re one of those nerds who files taxes early, you can schedule the credit card transaction for later so you don’t take that financial hit until you absolutely have to. Also, paying by credit card is an option for folks who simply don’t have the cash to pay their tax bills, though putting it on your credit card balance can quickly become a con (more on this later).
• Reward Points – If you’ve got a $100,000 tax bill (and some do), that can add up to a lot of frequent flyer miles. Rewards junkies should be pleased with this additional opportunity to rack up the free stuff.
• Security - The IRS uses the same credit card processing system as Macy’s or Target. As such, you’re protected by the same anti-fraud measures.
• Fees are Tax Deductible – It may be small potatoes, but every bit counts. You can deduct your convenience fee as an itemized business or personal deduction.

Cons of Paying Taxes by Debit or Credit Card

• Fees – The fees range from a low of $3.95 flat charge per transaction to a whopping 2.35% percentage of your total tax bill. With a $5,000 tax liability, you’re looking at a convenience fee of $117.50 – a high price to pay for saving a stamp.
• Higher Interest Rates – If you’re paying by credit card because you’re strapped for cash, you should be aware that there are some other options available. The IRS has an installment plan with interest rates as low as 4% (a sweet deal if your credit card APR is in the double digits) which you can get by filling out Form 9465.
• Card Rejections Can Lead to Big Trouble - If you don’t have the credit line or checking balance to cover your tax bill on the transaction date, it could lead to even more hot water. A rejected card can lead to a late tax payment which introduces even more penalties.
• Responsibility - If the service provider drops the ball for any reason and doesn’t get your money to the IRS, it’s your problem. Even though it’s not your fault, you’ll be responsible for any fees, penalties or other delinquent charges – so be sure you choose a third-party service provider that you can trust.

Don’t Get Scammed

Undoubtedly, the scammers will try to use awareness of this option to their advantage – so it’s your duty to be vigilant. To be safe, only use the providers officially approved by the IRS and never write your credit card information down on your tax return. Also, make sure you get a confirmation number – even if you complete your transaction by phone.

When all is said and done, take a look at your credit card bill. You’ll see two transactions: one for the amount of your tax bill and one for the convenience charge. The first will appear as:

United States Treasury Tax Payment

The second will be some variation of “Tax Payment Convenience Fee.” Don’t be alarmed if it’s something slightly different (i.e. the service provider’s company name). But do investigate if your tax bill and the convenience fee are lumped together in one transaction.

Ready to pay your taxes by credit card? Here’s a list of the IRS approved third-party service providers:

• Official Payments Corporation – Debit fee: $3.95/Credit Fee: 2.35%
• Pay1040.com – Debit fee: $3.89/Credit fee: 2.35%
• PayUSATax.com – Debit fee: $3.89/Credit fee: 1.95%
• FileYourTaxes.com – Credit/Debit fee: 3.93%
• TurboTax – Credit/Debit fee: 2.35%

Also note that these fees may change and that most providers have a minimum convenience fee of $1.00.

Credit or Debit? It’s Becoming Harder to Tell the Difference

Last March, we did a breakdown of debit cards vs. credit cards to show you the differences between the two plastic doppelgangers. Fast forward two years, and suddenly, the ying is starting to look and act a whole lot like the yang. Debit cards are accepted everywhere a credit card is, have rewards programs and, hey, they even have hidden fees and nefarious traps. But why are debit cards acting a lot more like credit cards these days? According to DailyFinance, it’s because credit cards are dead. And it wasn’t even Obama who killed them.

It was you! You and me, that is – the consumers. We were fed up with the wavering interest rates, devastating fees and bruises to our credit history. But instead of kicking the plastic, we eased down to a reasonable facsimile: the debit card. It works like a credit card, it looks and (probably) tastes like a credit card, but because you’re drawing from your own bank account and not being charged any interest, it’s a much smoother ride with less surprises.

Debit Cards Close the Gap

According to eCommerce Journal, Visa customers’ debit card spending surpassed their credit card spending in 2008. Visa cardholders spent $206 billion in debit purchases – mostly on necessities, like food and clothing – and $203 billion in credit purchases. Those figures aren’t widely different on theri face, but consider this: this is the first time in history that debit card spending has exceeded that of credit spending for Visa. The paradigms are shifting.

Debit vs. Cash: No Contest

While consumers cite greater convenience and security over cash and checks as one of the main boons of debit, card issuers are doing their part as well to promote debit card usage. With features like Zero Liability from Visa and PayPass from MasterCard, debit is simply the easiest way to pay. While a thief can nab your wallet or forge a check, your debit card has certain built-in protections that safeguard your assets in the case of identity theft. Even if you are victim of a skimming or phishing scam, you can quickly control your damage with a quick call to your card company – in most cases you’ll be liable for less than $50, even if the crook wipes you out. Plus, when you pay with a debit card you don’t ever have to deal with those pesky pennies.

You’ve Got Rewards!

But perhaps more significant to the shift is in rewards. One of the main hooks of credit cards has always been the opportunity to accrue points, cashback and other free stuff from your spending. These perks drove shoppers to use cards even when they had the cash on hand. The most responsible ones would simply pocket the points and pay off their balance as soon as they got home. But with card issuers offering rewards programs for debit purchases, there’s no need for this slice of the cardholder pie to even bother with credit cards. Things work out nicely for the issuers, too – retailers have to kick back upwards of 2.1% per debit transaction.

Here Come the Catches

Still, that 2.1% per swipe is, apparently, not doing enough for the card companies’ bottom lines. Those fees from over-the-limit spending, finance charges, late fees and membership costs that caused cardholders to flee from credit in droves are exactly what were making card issuers weathy. But like rats abandoning a sinking ship for one that’s afloat, those parasitic caveats and gotchas have followed the crowd to debit cards.

Since the beginning, the danger of overdraft has existed. But now, instead of reeling you in when you overstep your checking balance by denying your card, banks and issuers are automatically fronting you the money so the transaction goes through. You won’t know your overdrawn until the next time you look at your statement. Meanwhile, the bank charges you a hefty $25 to $35 fee per transaction for the “convenience” of covering you while you were short. It’s a racket that’s earning banks upwards of $38.5 billion in overdraft fees.

This may be preferable to having your check bounce and your utilities or mortgage payments become delinquent. But anyone who has come to the cold revelation that they are overdrawn only to next discover that they’ve been charged hundreds of dollars of overdraft fines on top of it is unlikely to rejoice.

Push Me, Pull You

Meanwhile, while debit cards are starting to resemble credit cards more, so too are credit cards changing. One of the main reason why debit wins over credit is the danger to a consumer’s credit rating, or a credit history that is already prohibitive of a traditional credit card. But with new prepaid credit cards, even those with little or bad credit can carry a card. The credit limit of a prepaid credit card is commensurate with how much the cardholder pays into the account. So, if the holder prepaid $1,000, he or she could spend $1,000 – after that, the card would be denied.

But wait a minute – isn’t that exactly the same as a debit card? Replace “credit limit” with “checking account balance” and basically, yes, it is the same. But the important difference is that, as of now, the credit bureaus still consider prepaids credit accounts. That means you can slowly build your credit using them (though likely no better than with a secured card). However, as with all cards for those with bad credit, there is a circuitous labyrinth of fees and terms. Plus, the system is somewhat rife for exploitation – meaning that FICO might take preventative action, much like they did in order to stop piggybacking.

But the moral of the story is this: as restrictions on issuers (such as the C-Card Act) continue to make debit cards more competiitive, card companies will begin making changes in order to keep their earnings up. And until Obama comes up with a Debit CARD Act, you may have to be just as vigilant with your debit card as you were with your credit card.

Credit Score Strategy: Paying in Full vs. Credit Limit Increases

There’s this pervasive myth going around that paying off your credit card balance in full each month will score you points (literally) with TransUnion, Equifax and Experian. The fact of the matter is that it won’t. And, in fact, you could even be hurting your credit score by purposefully racking up a high balance and then paying it off before incurring a finance charge. Sound crazy? I’ll explain.

Paying off your credit card balance in full is definitely a good thing. The benefits include:

• Not paying any finance charges.
• Reducing the risk of going into debt.
• Avoiding late or delinquent payments (which DO go on your credit report).
• Being a good customer in the eyes of your credit card company.

I added that obnoxious emphasis to the last point because there is the key difference between building credit and building goodwill with your credit card company. Both are important to your credit score, but in different ways.

FICO Factors – How Punctuality Matters

Payment history eats up a whopping 35% of the pie that makes up your credit scoring factors. But the credit reporting bureaus are only concerned about whether you pay the minimum amount on time. They could care less if you overachieve by paying off your credit card in full each month. That’s because the carrying a credit card balance is part of the agreement between you and your credit card company. You’re not breaking any rules by doing so. While incurring finance charges may be less economical on a personal finance level, it is by no means a penalty and is not indicative of your inability or unwillingness to stick to the terms of your contract. It’s merely a money management choice.

Timing Issues and High Balances

In fact, paying off your debt in full each month may even less beneficial than you thought because of the way the credit reporting bureaus pull your information. The second biggest slice of the FICO pie is amount owed, which takes up 30%. This is a measurement of your credit to debt ratio, or how much you owe vs. how much you can borrow. So, if you pay off your credit card balance every month, that ratio should be very low, right? Nearly zero, even. Wrong.

Let’s say that you have a balance of $1,000 on your credit card with a $2,000 limit and you intend to pay it off on the 23rd. Meanwhile, the credit reporting agencies pull your file on the 22nd. Guess what? It’s going to show up as if you had a 50% credit utilization, even though it would’ve been zero if they would’ve pulled the information two days later. This is an extreme example, but having a credit utilization of 30% or more can bring down your score by 10 to 20 points.

Fixing the Credit Ratio Quirk

It’s not all bad news, especially if you really are in a position to pay off your credit card in full each month. If so, that means that you have reasonable income and assets and probably qualify for a credit line increase. And since you’ve been such a great, responsible customer who has never missed a payment, your chances for getting a credit line increase are even higher.

Extending your credit line will directly help your overall credit to debt ratio. But it also may help to start charging less on your credit card as well. Use some of that cash that you were saving for the end of the month and buy things the old fashioned way until you get your average credit utilization well below 30 percent at any given time. In this way, you’ll be attacking the issue from both ends and you can reclaim some of those stray FICO points that you deserve.

Got a tip for cutting down your credit to debt ratio? Share it in the comments!