Paying Your Taxes With a Credit Card: It's Tricky, But It Can Be Profitable

Amount You Owe
Getty Images
By Jason Steele

The Internal Revenue Service authorizes select companies to process credit and debit cards on its behalf, but these companies charge taxpayers a processing fee of 1.87 to 2.35 percent of the taxes paid, make it unwise to pay your taxes with most credit cards.

But what if there were a way to charge your tax payments to a credit card that earned rewards worth more than the fees paid? This is what savvy cardholders can do when they choose the right credit card to pay their tax bill. (The IRS posts a list of the companies authorized to accept federal tax payments on its behalf, along with the fees charged.) Furthermore, an ingenious loophole can allow taxpayers to pay a fee smaller than 1.87%.

When Rewards Are Worth More Than the Fee

The lowest fee charged by a website authorized by the IRS to accept tax payments is 1.87 percent. These sites are Value Tax Payment and payUSAtax, which are nearly identical products operated by Value Payment Systems. At this rate, any card that offers rewards worth more than 1.87 percent would be worth using to pay a tax bill.

For example, the Venture Rewards card from Capital One offers double miles on all purchases, and each mile is worth one cent towards gift cards or as a statement credit towards any travel purchase. This means that each purchase returns rewards worth 2 percent of spending. So if a cardholder paid a $5,000 tax bill at this site, he or she would incur a $93.50 fee, but earn $100 worth of rewards for a net benefit of $7.50. While this might not be a large amount, it does mean that the taxpayer is making up more than the difference for the credit card transaction fee.

The Fidelity Investments Rewards American Express cards offer 2 percent cash back rewards that are deposited in a qualifying account with Fidelity Investments, the same calculation will apply if a taxpayer uses one of these cards to make a tax payment.

With the Starwood Preferred Guest card from American Express, cardholders earn one point per dollar spent on all purchases and these points can then be transferred to frequent flier miles. In addition, cardholders receive a 5,000-point bonus when they transfer 20,000 points to miles at once, so each dollar spent on this card translates to 1.25 airline miles. If cardholders are able to redeem those miles for tickets worth 1.5 cents a mile or more, than it could make sense to pay their taxes with this card. For example, a cardholder who transfers 20,000 Starpoints to American Airlines will receive 25,000 AAdvantage miles. If those miles are used for a domestic round-trip award ticket worth $375 or more, than the cardholder comes out ahead when paying taxes with the Starwood card.

When Rewards Are Worth Less Than the Fee

In other instances, it can still make sense to pay a tax bill even if the spending rewards are worth less than the processing fee. This is the case when cardholders are close to reaching the spending threshold to earn a large bonus. For example, the Starwood card offers a 15,000-point bonus to new applicants who spend $5,000 within the first six months of opening an account. If paying taxes with this card will enable cardholders to reach this spending threshold in time, the value of the points received can be well worth the tax payment processing fees.

Maximizing Rewards and Shrinking the Fee

The payment processors will accept tax payments from debit cards with a flat fee starting at $2.49 per payment. Although there are almost no debit cards left that offer rewards, savvy taxpayers can still use their credit card to buy prepaid debit cards sold as gift cards at grocery stores, drug stores, gas stations and even some hardware stores. In this case, taxpayers will pay a $4.95 fee when they purchase a $500 gift card, plus a flat debit card fee for each card payment of $2.49 or more. So the combined total of gift card fees and debit card fees will be equal to about 1.5 percent of the taxes paid (for each $500 payment), which is a small savings off of the 1.87 percent credit card fee.

%VIRTUAL-article-sponsoredlinks%The real advantage of purchasing prepaid debit cards with your credit card is that you can do so where bonus rewards are offered. For instance, Wells Fargo currently offers several cards that feature 5 percent cash back at gas stations, grocery and drugstore purchases for cardholders' first six months, which means that their cardholders can earn rewards worth 3.5 percent of their taxes paid. Furthermore, the American Express Blue Cash Preferred offers 6 percent cash back from spending at grocery stores on cardholder's first $6,000 of eligible spending each year, so taxpayers could conceivably earn rewards worth as much as 4.5 percent of their tax payments. This works out to a $225 savings on a $5,000 tax bill.

Disadvantages of Paying Your Taxes With a Credit Card

First, it is unwise to finance a tax bill with a credit card as any interest accrued and paid will vastly outweigh any savings. And if the tax payment causes you to use a high percentage of your available credit, your credit scores may suffer. (If you want to know how your debt is affecting your credit scores, there are free tools that allow you to monitor them, including Credit.com's Credit Report Card, which also gives you an overview of the factors that are affecting your scores.)

These strategies are only worthwhile for those who pay their statement balance in full each month. Additionally, purchasing gift cards with a credit card can be inconvenient and time-consuming. Taxpayers will have to register each gift card with their ZIP code, and some processors have a limit on the number of gift cards they can accept for a payment. In my experience, Choice Pay representatives will gladly accept multiple debit cards over the telephone, but the telephone call is time-consuming and their fee is slightly higher at $3.48 per card.

At publishing time, the Capital One Venture Rewards card, Starwood Preferred Guest card from American Express and American Express Blue Cash Preferred are offered through Credit.com product pages, and Credit.com may be compensated if our users apply for and ultimately sign up these cards. However, this relationship does not result in any preferential editorial treatment.

More from Credit.com:

Tax Tips for Real Estate Agents and Brokers

Most real estate agents and brokers receive income in the form of commissions from sales transactions. You're generally not considered an employee under federal tax guidelines, but rather a self-employed sole proprietor, even if you're an agent or broker working for a real estate brokerage firm. This self-employed status allows you to deduct many of the expenses you incur in your real estate sales or property management activities. Careful record keeping and knowing your eligible write-offs are key to getting all of the tax deductions you're entitled to.

Read More

Brought to you by TurboTax.com

What is the Educator Expense Tax Deduction?

The Educator Expense Tax Deduction allows teachers and certain academic administrators to deduct a portion of the costs of technology, supplies, and certain training. Here’s what teachers need to know about taking the Educator Expense Deduction on their tax returns.

Read More

Brought to you by TurboTax.com

Self-Employed Less Than a Year? How to Do Your Taxes

Have you been self-employed less than a year? If you’re just starting out, it’s possible you worked at a job earlier in the tax year before making the switch to self-employment, or you’re working multiple jobs. In this case, you may have more than once source of income you’ll need to report on your income tax return.

Read More

Brought to you by TurboTax.com

Taxes for Grads: Do Scholarships Count as Taxable Income?

Heading off to college to broaden your horizons is exciting, but funding your education via scholarships? That's even better. Scholarships often provide a path to education that might not be feasible otherwise, which is why the Internal Revenue Service (IRS) can be generous in minimizing students' tax obligations. But sometimes scholarship money does count as income, and it’s better to find out now if your scholarship adds to your tax liability than to have a surprise later. Here’s how to decode your scholarship taxation.

Read More

Brought to you by TurboTax.com
Read Full Story
Your resource on tax filing
Tax season is here! Check out the Tax Center on AOL Finance for all the tips and tools you need to maximize your return.

Want more news like this?

Sign up for Finance Report by AOL and get everything from business news to personal finance tips delivered directly to your inbox daily!

Subscribe to our other newsletters

Emails may offer personalized content or ads. Learn more. You may unsubscribe any time.