Should you pay your taxes with a credit card?

Tax time can be stressful, particularly if you don’t have the money to pay what you owe. While a credit card can be a convenient way to cover the bill, make sure you understand all the ways it will cost you.

Tax laws forbid Uncle Sam from directly accepting credit cards, so the federal government farms out that option to three third-party services: PayUSAtax, Pay1040 and ACI Payments Inc. All of these options come with convenience fees. The convenience fee for paying 2021 taxes with credit cards ranges from 1.87% to 3.93% of the payment with a $2.50 to $3.95 minimum, depending on the third-party service you use.

You can also pay by credit card if you use tax preparation software that has e-file and e-pay built in, such as TurboTax, though there would still be a convenience fee charged by the payment processor. Another way to pay is via digital wallet, an option for which regular debit or credit card fees would apply.

Let’s look at a hypothetical $4,000 tax bill and what it would cost to pay by credit card.

What does it cost to pay your taxes with a credit card?

Balance transfer card buys you time, saves money

When you shift your debt from Uncle Sam to your credit card issuer, you pay interest on whatever balance you carry. If you pay only minimum payments, this year’s tax bill could haunt you for a long time.

You could open a balance transfer credit card and transfer your tax payment to it. Balance transfer offers to people with good credit typically include an interest-free period of a few months to more than a year. A year-long promotional credit card rate of 0% would likely make for a pretty sweet deal.

“But you’d better make a plan to pay that credit card off within the year, so it really is 0%,” warns Dawn W. Brolin, CEO of the CPA firm Powerful Accounting.

Also, keep in mind that if you are late on a payment, your interest rate could skyrocket.

You’ll typically pay a fee of about 3% to 5% of the balance amount you’re transferring, and people with less-than-perfect credit may not qualify for a transfer covering the full amount of the tax bill. Additionally, many credit card issuers have tightened their standards for balance transfer offers as the economy struggles from the coronavirus pandemic.

Cash advance convenience check is an expensive option

Credit card holders also can pay their tax bill with a cash advance convenience check, but this option comes with a high price. Cash advance convenience checks have steep transaction fees, high interest rates and no grace period, making them an expensive choice.

“People always need to read the fine print,” says Mark Foster, director of education for Credit Counseling of Arkansas. “Cash advances typically have a higher interest rate than other purchases and they don’t typically have a grace period.”

IRS installment agreement spreads out payments

Before whipping out the plastic, compare the costs of paying by credit card with the costs of an installment agreement with the IRS.

That’s what Dana Andrews of Wheatfield, New York, did when he had a $15,000 tax bill. After weighing whether to put the tax bill on his credit card versus working with the IRS, Andrews decided to go with the installment plan.

With an installment plan, taxpayers typically get six years to pay off a debt.

Of course, you will pay a fee to set up the installment plan ($130 or $225, depending on whether you apply online or by mail, phone or at an IRS office), interest and late penalties. The setup fee drops to $31 or $107 if you have the payments automatically deducted from your bank account, depending on how you apply. Taxpayers whose income meets the Department of Health and Human Services’ poverty guidelines may be able to qualify for having the setup fee waived.

The costs don’t stop there. Even if you have an installment plan, you still must pay a late penalty of 0.25% per month until the debt is paid in full. Interest, compounded daily, must also be factored in. The interest rate, which equals the federal short-term rate plus 3%, is set quarterly.

If you select an installment agreement, know that you won’t receive future tax refunds until your debt is paid. Instead, the refunds will be applied to any remaining debt.

If you think you can pay off the amount you owe in 120 days or less, you can apply for a short-term payment plan. There is no setup fee whether you apply online or via phone, mail or in person. However, you will have to pay any penalties that have accrued, as well as interest until you’ve paid off the entire balance.

Credit card vs. IRS installment agreement

Some – including the IRS – tout using credit cards to make tax payments as a way to earn rewards. However, card issuers typically award rewards worth 1% of your spending, while the third-party convenience fee could be nearly 2%.

“Taxpayers would likely be paying more to the third party than they would get back for redeeming points,” says Michael Rozbruch, founder of Michael Rozbruch’s Tax and Business Solutions Academy.

Another thing to consider: An IRS installment agreement won’t affect your credit, while paying by credit card would increase your debt load. The latter could increase your credit utilization ratio, which lowers your score, leaving you with increased interest rates and a reduced credit line, Foster says.

Bottom line

Ideally, you should have enough money withheld from your earnings throughout the year so you don’t have to scramble for cash on tax day, says Brolin. But if your savings won’t cover the taxes you owe, you have to determine which form of payment will cost you the least.

Regardless of what option you choose, plan to have more money set aside to ensure that you don’t fall short next year.

“If you don’t make some adjustments, whatever happened this year will probably happen again,” Foster says.