Credit Cards and Taxes
I was poking around on the IRS website the other day and saw that the use of credit and debit cards to pay taxes was up to 54% last year and that number was expected to dramatically increase this year. What?! People actually use their credit card to pay for taxes? I thought it a good topic for today’s discussion.
Most of the major banks and credit card companies are offering special incentives to pay your taxes with your credit card; the most popular being double airline miles for tax related purchases. Naturally, most of the credit card companies want you to pay your taxes with your credit card. They know a large percentage of the population will likely have a larger tax bill than they can realistically pay off at the end of the month. In addition, using your credit card to pay taxes means you get a 2.49% surcharge tacked on for processing through a third party. Normally the consumer would never see this charge. Merchants usually pick up this cost in the form of their fee agreements and just hike up their prices to recoup. But, credit card companies made special provisions in their agreements with the IRS to transfer those fees to the consumer. You see, Uncle Sam wants all of his money and isn’t about to let 2.49% go to the credit card companies in fees.
Working in the financial industry, I know a lot of people go to their bank or credit union to get official checks to pay their taxes. This year, the average dollar amount I saw was about $5000. If you decided to pay that amount with your credit card, at 2.49% you’re paying a convenience fee of $124.50 just to pay your taxes. The logic behind this seems a little odd to me. You already have to pay $5000 to the IRS, why do you want to give the credit card company $124 when you can electronically send your payment for free, or pay $.41 for a stamp if you prefer mail? Plus, if you can’t pay this off at the end of the month, then you’re paying interest on the outstanding balance.
So, I did a little digging around on the internet to see what some responses were to this.
One guy said that he was self-employed so his tax bill could be pretty hefty. Given that his credit card company gave double airline miles, he basically got a free ticket. Then he said he transferred the balance to a 2.99% card good until the balance was paid off, and dumped the cash that he was going to use to pay his taxes into a 4% savings account.
Ok, first of all we know that he has no intention of paying this off at the end of the month. So, not only did he pay the 2.49% surcharge he’s also going to be paying 2.99% until the balance is paid in full. Next we have the fact that he dumped the cash into a savings account. Realistically, his spread is hardly worth anything – it doesn’t even cover inflation. He’s actually coming out behind if you look at it. 4% for the savings minus the 2.99% he’s paying on the credit card leaves him earning interest at 1.01%; however, he paid 2.49% up front for the convenience to do all of this. He didn’t really make any money in this deal. Not to mention the fact that a savings account isn’t a fixed rate, its variable, so the likelihood is that rate can, and probably will, go down. Yes, he got a free airline ticket out of the deal, but was the cost of that ticket and the points it took worth all that he’s paying in interest?
Probably not.
Another argument for paying your taxes with a credit card was that if you owe a small amount the 2.49% fee wouldn’t amount to much AND you would be getting the rewards that come with it.
Fine, let’s say you owe $200. The surcharge works out to be like $5. That’s not a lot, you’re right. But, how many miles are you really getting with that? Maybe 400? And how many miles does it take to purchase a roundtrip ticket? So, you still have a long way to go before you can actually redeem the miles. It wasn’t really that big of an advantage on the points, you could have just paid cash – especially if you don’t use the card often enough to rack up more points. Furthermore, what happens if something comes up and you can’t pay the balance at the end of the month? Then you’re paying interest on the $200 and the $5, all for 400 flyer miles? That doesn’t seem very cost effective to me.
Bottom line: If you know without a shadow of a doubt that you can pay that credit card off at the end of the month, then it may not be a bad idea to get some airline points out of the deal – if you don’t mind paying a convenience fee. Personally, I don’t want to give the credit card company any more money then I have to. I’m not paying a surcharge to them on top of paying my taxes. But, some people might not think this a bad way to go.
However, if you can’t pay off your balance at the end of the month then using your credit card is a BAD idea, even if you think you’re being smart and putting the cash in an interest bearing account. As you saw from the math above, you come out with the short end of the stick in that deal. It’s not worth it. You’re better off paying the taxes in cash and not owing anyone money. While the lure of a free ticket can be tempting, you have to figure out how much you’re actually paying for that so-called “free” ticket. If it costs more than you’d normally pay, then it’s not in your best interest.
Have you used your credit card to pay for taxes? Why or why not?
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Nope – I’ve never paid for my taxes with my credit card – to be honest it never even entered my mind.
But now that I know its a possibility I still don’t think I’d use a credit card especially since it would end up costing me more money than simply writing a check.