Tax Day is approaching fast, but did you know that paying Taxes can impact your Credit Score? That's right, and today I'm gonna explain everything you need to know before you pay that Tax Bill!
While Taxes themselves don't directly impact Credit Reports, failing to pay your Tax Bill or using Credit to pay your Tax Debt can indirectly hurt your Credit in significant ways.
So today, I'm going to discuss how unpaid Taxes can affect your Credit and how paying your Taxes can also impact your Credit.
If that sounds confusing, don't worry. It's pretty simple, and I'll explain everything.
HOW THIS RELATES TO US
Each year, after all the Tax Returns are filed, about 75% of Americans receive a Refund, and 25% receive a Bill.
A Tax Bill starts the collection process, which continues until your Tax Debt is paid off or the collection period expires.
In 2020, the average Tax Debt reached over $16,000.
The most common causes for Tax Debt included "owing more than expected," "Unfiled Taxes," and "Divorce."
Not paying your Tax Bill on time may cause penalties, interest on penalties, a Tax Lien, an IRS Levy action, or in some cases, if the Debt goes totally unpaid, it's even possible to get banned from traveling internationally.
So, if I needed to make it clear: PAY YOUR TAXES!
For those new to Credit Repair, a Tax Lien is a legal claim the government places on property or assets when a Tax Bill is past due.
If the Tax Bill remains unpaid, the Tax Lien can become a Tax Levy which is the legal seizure of your property, assets, bank accounts, and your wages.
In the past, Tax Liens and other judgments dropped Credit Scores by 100 points or more. Repaid Tax Liens would appear on Credit Reports for up to 7 years, and Unpaid Tax Liens could remain on your reports indefinitely.
I had a Tax Lien years ago. I was in show business, which meant I was out of work most of the time, but one year, I actually had a lot of gigs. But then, the next year, I had no gigs, and I was back to living on my credit cards. And then I got that tax bill. It was for over $20,000, which was more money than I could imagine having at one time. And I had no money to pay it. I didn't have a job. And that Tax Lien was horrible. I eventually paid it off in installments, but it continued to haunt me for seven years. It was awful and embarrassing anytime someone looked at my credit report.
However, in 2018, Federal and State Tax Liens and other Tax related court judgments were removed from Credit Reports, which is awesome.
But why did the Credit Bureaus stop including them in their Reports?
Well, the change was made as a result of a study by the Consumer Financial Protection Bureau that found many Tax penalties were not accurately reported, leading to unfair negative impacts on consumers.
So, in 2015, to improve the accuracy of public record data collection and reporting, the three Credit Bureaus partnered with more than 30 US State Attorneys General and agreed to the National Consumer Assistance Plan.
Under this plan, the Tax penalties and other judgments disappeared from Credit Reports. Hooray!
But even though they no longer appear on Credit Reports, there's still a financial impact.
THE THING TO REMEMBER
Tax Penalties like Liens and Levies are all Public Records.
Lenders can still find them and use them to decide your financial future.
So, you want to avoid Tax penalties whenever possible. If you can pay your Taxes on time and in full, PAY THEM!
Just don't overextend yourself and go into worse debt to pay them!
WHY THIS IS IMPORTANT
If you're in a position where you need to borrow money in order to pay your Tax Bill, that's okay. Just be extremely careful how you borrow, or you could dig yourself into a worse financial hole.
If you pay your Tax Bill with the wrong Credit Card and can't keep up with the high-interest rates, the penalties for Late Payments can still damage your Credit, just like any other Late Payment.
Or, if you max out your available credit in order to pay your Tax Bill, the high Credit Utilization will damage your Credit Score. For example, it's not uncommon for one maxed-out Credit Card to drop a Credit Score 45 points.
Similarly, if you choose to pay your Tax Bill with a Personal Loan, and the repayment terms are more than you can afford, you can default, fall into Collections, and do even worse damage to your long-term finances.
In most cases, the best option for paying a Tax Bill and minimizing the impact it has on your Credit is to set up a Payment Plan with the IRS.
WHAT YOU NEED TO KNOW
The IRS recommends if you can't pay the full amount owed by the filing deadline, you should still file your Tax return, pay as much as you can at the due date, and request a Payment Plan for the remaining balance.
Your specific financial circumstances determine if you qualify for a Short-Term Payment Plan (which requires you to pay the full amount in 180 days or less) or a Long-Term Payment Plan (which requires a monthly Installment Agreement).
You may be eligible for a Short-Term Payment Plan if you owe less than $100,000 in combined tax, penalties, and interest.
You may be eligible for a Long-Term Payment Plan if you owe $50,000 or less in combined tax, penalties, and interest and have filed all required returns.
Individuals can apply for IRS Payment Plans at IRS.Gov using their Online Payment Agreement Tool or by submitting the Form 9465 - Installment Agreement Request and attaching it to the front of your Tax Return.
It's important to note that setting up an IRS Payment Plan does not trigger any reports to the Credit Bureaus. So you're safe there.
Also, when a Payment Plan is requested, with certain exceptions, the IRS is generally prohibited from Levying. The IRS's time to collect is suspended or prolonged while an Installment Agreement is pending.
If you're concerned about your credit score during tax season, I recommend that you turn to a Credit Repair Professional with experience as a Tax Preparer.
If you're a Credit Repair Professional, I recommend contacting your clients and explaining how they can protect their credit as they pay their Taxes.
MY FINAL POINT
Your Taxes may not affect your Credit Report directly, but the indirect impact can still be serious! So, if you receive a Tax Bill, Don't ignore it! Take action immediately. Don't let it become a crippling Tax Debt. Contact the IRS. Determine the best payment option, and avoid falling into a worse financial trap!
I'LL END BY SAYING...
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