Keep a Tax Debt From Ruining Your Credit

Keep Tax Debt from Ruining Credit

The IRS has more power than any other creditor. Unlike private creditors, the IRS can directly garnish your wages and levy your bank accounts. Tax liens are also one of the biggest negative items for credit scoring purposes. If you owe taxes that you can’t pay, here are your options and how they affect your credit.

Not Filing a Tax Return

Not filing a tax return to try to keep the IRS from finding out you owe taxes is one of the worst things you can do. It doesn’t even work because the IRS will receive copies of your W2s and 1099s from your employers and banks.

When the IRS realizes that you owed taxes and failed to file returns, the penalties are typically ten times greater than if you filed but paid late. The IRS will also be less willing to work with you after you’ve attempted to evade taxes. For large debts or multiple un-filed returns, you may also face criminal prosecution.

As far as your credit score is concerned, the IRS will begin the collections process and issue a tax lien as quickly as possible.

Not Paying When Filing

If you don’t pay your taxes in full by the time your return is due, you will be charged late fees and interest starting from the due date. However, if you still filed a return on time, the IRS takes a slightly friendlier approach to collections.

You will receive a bill and at least a second notice before the IRS files a tax lien. As long as you meet the deadline to avoid the lien, your credit report will never be affected.

Typically, your options will either be to arrange full payment within 120 days of the due date or to enter into an installment agreement.

Personal Loan/Credit Card

The IRS recommends that you take out a personal loan or charge your taxes to a credit card instead of using IRS repayment options. They gain the advantage of receiving immediate payment in full.

Your advantage is less clear. You avoid IRS penalties and interest, but your loan or credit card interest charges might be higher. You’ll also avoid the IRS collections process, but IRS collections don’t impact your credit if you follow the steps to avoid the lien.

When you apply for a loan or credit card, the credit inquiry will lower your credit score, and your average age of accounts credit score factor will be reduced. The increase in your credit balance will also lower your credit score. However, once you pay off the debt, you’ll have additional positive payment history on your credit report.

Installment Agreement

An installment agreement is a payment plan directly with the IRS. It may be advantageous if you can’t get a good rate on a loan or credit card.

Installment agreements never show up on your credit report, so it won’t affect your credit score. If you sign up for automatic payments, you’ll also avoid a tax lien.

However, if you default on an installment agreement, the IRS may cancel the agreement and issue a tax lien. There are several ways to default, including the following.

•     Late payments

•     Bounced payments

•     Failure to have adequate withholding or estimated tax payments  for the current tax year

•     Any other late taxes

Offer in Compromise

An offer in compromise is an agreement to settle a tax debt for less than it’s worth. The offer can be either a lump sum payment or a payment plan.

Unlike settlements or charge offs on credit card accounts, offers in compromise are not reflected on your credit report. Because the tax is considered to be settled in full, the IRS will withdraw any liens once you’ve completed the offer.

The downside is that it’s incredibly difficult to be approved for an offer in compromise. The IRS must believe that you have almost no chance of ever paying in full. This is typically only when you are disabled or well past retirement age.



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Tax Lien

If you can’t pay your taxes in full, make payment arrangements or complete your payment plan, the IRS will issue a tax lien. Tax liens will destroy even a nearly perfect credit score. They’re also automatically disqualifying for many loans, jobs and rentals.

The good news is that the IRS almost never issues liens for tax debts under $10,000. They believe the negative effect on your credit report will make it harder for you to pay back a tax debt at that level.

If you have a tax lien, there are three ways to get it off of your credit report:

  • Paying in full: Once your tax debt is paid in full, whether in a single payment or through installments, the lien will be released within 30 days. At that time, you can request the lien be withdrawn.
  • Discharge of property: If you need to sell your home or a vehicle, you can apply to have the lien discharged on that specific piece of property. Typically, the IRS will expect a portion of the sale proceeds to approve your application.
  • Withdrawal: You may also be eligible to have a tax lien withdrawn and removed from your credit report before you pay in full. Requirements include being current on all tax returns and estimated taxes as well as having a direct debit installment agreement to satisfy your past-due taxes.

Unlike other negative credit report items that stay on for seven years, once liens are withdrawn, they are completely erased from your credit report as if they never happened.

Sources:

  • https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Understanding-a-Federal-Tax-Lien
  • https://www.irs.gov/taxtopics/tc201.html
  • https://www.irs.gov/Individuals/Payment-Plans-Installment-Agreements
  • https://www.irs.gov/Individuals/Offer-in-Compromise-1
  • https://www.irs.gov/taxtopics/tc653.html
  • https://www.irs.gov/Help-&-Resources/Tools-&-FAQs/FAQs-for-Individuals/Frequently-Asked-Tax-Questions-&-Answers/IRS-Procedures/Collection-Procedural-Questions/Collection-Procedural-Questions-3
  • https://www.irs.gov/uac/What-to-Know-about-Late-Filing-and-Late-Paying-Penalties
  • http://www.taxpayeradvocate.irs.gov/get-help/i-can-t-pay-my-taxes
  • http://www.cbsnews.com/news/stop-the-irs-from-destroying-your-credit-4-moves/