Planning for your tax bill? How it can affect your credit score

Posted by citiYellow

Saturday, 21 January 2012 07:29

(ARA) - Your resolutions are made and you even have a game plan to make sure 2012 is the year you stick to them. But before you can really get going on achieving your personal goals in the new year, you'll need to wrap up some unfinished business from 2011 - your taxes.

Even though tax season comes every year at the same time, many Americans face their tax bill with no plan for how to manage it. Facing unbudgeted debt is a situation that can lead you to make reactive, desperate decisions that could negatively affect your credit score and your finances long after April 15. Similarly, an unexpected tax refund that turns into "fun money" can be an opportunity lost when it comes to managing your credit and overall financial health.

Not sure if you'll owe? Visit IRS.gov for an online withholding calculator, or search for a free tax estimator. Many manufacturers of tax preparation software offer free estimators on their websites.

Once you have an idea of how much, if anything, you'll owe, evaluate your payment options. Take steps to understand your credit, and consider the relationship between tax bills, debt payments and credit before you decide how you will pay your taxes.

Cash: Of course, the payment method that will have the least amount of impact on your credit is to pay what you owe in full with cash. In this economy, that may not be a realistic option for many people.

Credit Cards: The IRS accepts credit card payments, an option that has become increasingly popular in the recent past. But before you use plastic to pay your taxes, make sure you know your credit score, credit status and how both might be affected if you use credit to pay your taxes.

Websites like freecreditscore.com can help you understand the potential impact of big credit expenditures or delayed payments on existing debts. The site's credit score estimator helps members plan ahead to see how major financial decisions, like maxing out a credit card (if necessary) to fund a tax bill might impact your personal credit.

Keep in mind that in addition to paying interest on the balance carried on your credit card, you may face other fees and conditions for using your card to pay your taxes. Check with both the IRS and your card issuer.

Loans: You may also opt to use a bank loan - such as a home equity loan - to pay your tax bill. Again, this method of payment may have a larger impact than just interest expense. This loan will appear as debt on your personal credit until you are able to pay it off.

Payment Plan: Another option for paying your tax bill is to ask the IRS for a payment plan. According to the IRS website, there are several payment options that could help you if you can't pay your entire tax bill at once. Research your options and follow the website's instructions for corresponding with the IRS.

According to IRS.gov, if you file your tax return, owe money and do not include immediate payment, the service will send you a tax bill. That bill initiates the collection process, and will include an explanation of the balance due plus any penalties and interest.

Although you have many alternatives for dealing with your tax bill, not filing your tax return or not paying your bill are not among them. IRS.gov points out that bank or credit card interest rates and fees are "usually lower than the combination of interest and penalties imposed by the Internal Revenue Code."

Finally, keep in mind that your taxes can provide an opportunity to positively impact your financial health. Avoid the temptation to turn a tax refund into fun money - or set aside only a small percentage towards that purpose - and use your refund to help pay down outstanding debt. Lowering your ratio of credit used to credit available can help improve your credit score. And, if your debt is under control, consider applying your refund towards a retirement account. One day, you'll thank yourself for doing so.