4 Ways Taxes Can Impact Your Credit
By Mandi Woodruff
Since credit debt isn't exactly considered an income-booster, it's no wonder so many consumers forget how closely credit and taxes are intertwined.
Just ask the Citibank credit card customers who were stunned when the company suddenly decided to tax their frequent flier rewards, or the 6.4 million taxpayers estimated to pay taxes on relieved debt in 2012.
For insight into the little-known ways taxes and credit go hand in hand, we tapped Ken Lin, CEO of CreditKarma.com. Here are four examples:
Paying your tax bill late could damage your score
Just like your electricity and cable bills, falling behind on your tax payments could drag your credit score down. That's because the government could file a tax lien against you for taking too long to pay your bill. Since a lien is public record, it goes straight to credit reporting agencies and could stay on your credit report for as many as seven years, Lin warns. If your bill's too much to handle, be proactive and work out a repayment plan with the IRS instead.
Think twice before you pay taxes with your credit card
"When facing a hefty tax bill, many Americans might be tempted to pay their taxes with a credit card, if only to earn the reward points," Lin says. But before you fork over that plastic, keep in mind that the IRS will charge a processing fee of anywhere from 1.89% to 2.49% of the payment. "That means if you owe $10,000 in taxes, paying it on a credit card would cost you an additional $249 – well above the probable value of the credit card rewards earned," he notes.
Your credit card reward point "gifts" may be taxable
Back to those grumpy Citibank customers: Keep in mind that some of those sweet sign-up bonuses and rewards credit card companies have been using to bait new customers may be taxable. It all depends on how they were earned, Lin says. "Traditional rewards that are accumulated because of purchases made with credit cards are tax-exempt, but rewards that are not tied to purchases, like cash or miles bonuses for opening a new account, are taxable as the IRS views them as 'taxable property windfalls.'"
You'll pay taxes on your relieved debt
You might thank your lucky stars if a credit company decides to write off your debt, but remember that the IRS will consider that taxable income. "It's the same way with debt settlement," Lin says. "The remainder of the debt that you settled is subject to taxation." Keep an eye out for a 1099-C form if any debt was forgiven during the 2011 tax year.
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