If you're one of the many taxpayers who owe 2011 federal income taxes, you might be tempted to charge it to your credit card. Several years ago, the IRS partnered with several providers to give taxpayers the opportunity to pay with a credit or debit card. You could still pay by check, which is free, but the IRS included these new methods to reflect the changing times.
Unfortunately, paying with a credit or debit card almost never makes sense. There are two reasons why you shouldn't charge your taxes on your credit card.
Convenience fee. Credit card companies charge a fee to merchants to who accept payment using their cards. In all cases, the merchants simply pass those costs on to the consumer in higher prices. It's not a big deal when your pack of gum or DVD is a little pricier, but it can be extremely painful for larger purchases like a car (this is why most dealerships won't accept payment for a car using a credit card.) In the case of taxes, the payment processor will charge you a "convenience fee" on top of the taxes you owe.
Here are the four largest authorized payment providers and the fees they charge:
payUSAtax: 1.89 percent, minimum $3.89
Official Payments: 2.35 percent, minimum $3.95
Pay1040.com: 2.35 percent, minimum $3.89
Value Tax Payment: 2.29 percent, minimum $3.89
The fees for paying with a debit card are lower, usually a fixed amount of a few dollars. Since a debit card is linked to your checking account, why fork over even $3 to pay via debit card when you can write a check?
Interest rates. If you don't pay off your credit card balance, or if you currently carry a balance on your credit card, the interest rates your card charges you on that debt can be extremely high. You could be paying down that tax bill for years, at a punitive interest rate, and put yourself deeper into the debt hole. If you don't have the cash to pay your tax bill, the IRS offers installment plans with more reasonable interest rates than a credit card. There is an application process, including fees, but it's often better than using a credit card, especially if you can't pay it off immediately.
There is one exception to this rule, and that's if you use a credit card with a 0% APR promotional rate. With those promotions, you can often get a year of 0% interest to help you repay the tax debt. Even in those cases, it's dangerous because you subject yourself high interest rates if you fail to pay off that debt during the promotional period. This is an exception that should be exercised with extreme caution.
Finally, find out why you owe taxes this year and try to minimize the liability for next year. If it's because of underwithholding from your employer, work with your HR department to update your Form W4 so you aren't put in this situation again. You'll also need to take a look at quarterly estimated payments since our tax system is a "pay as you go system." You may be required to make estimated payments to avoid penalties next year, so I recommend speaking to a tax professional to get that sorted out.
Jim Wang writes about personal finance at Bargaineering.com. When he's not tackling money issues, he's usually looking forward to his next vacation and writing about it at Wanderlust Journey.