Taxes and Your Credit – Here’s What You Should Know

blog illustration image

Every year, as tax season rolls around, it feels like working your way through a maze, doesn’t it? There’s the rush to gather all your documents, the puzzle of deductions, and the hope for a refund paired with the fear of owing more. But have you ever stopped to consider how this annual ritual impacts something as crucial as your credit score? The relationship between taxes and credit is one many overlook, but it holds significant sway over our financial lives.

Taxes and Your Credit – What You Deserve to Know

Tax season brings a maze of forms, deductions, and hopes for a refund. But have you considered its impact on your credit score, a key to your financial health? While the days of direct IRS credit score hits are gone, unpaid taxes can still have serious consequences. Unpaid debts, including tax debt, can lead to collections and legal judgments that do impact your credit.

Refund Anticipation Loans: A Double-Edged Sword

As tax season approaches, it’s only natural to want to get the refund you’re owed as quickly as possible. And many Americans are tempted by the prospect of refund anticipation loans (RALs). RALs are short-term loans offered by tax preparation companies and lenders, based on your anticipated tax refund. With the promise of immediate access to your tax refund, RALs may look like an attractive option to quickly bridge financial gaps.

But here’s the catch: RALs come with fees and interest rates that can eat into the actual amount of your refund. The convenience of instant funds is often overshadowed by the high cost of borrowing, making it a less-than-ideal choice for most taxpayers.

When you sign for a RAL, the lender essentially advances you the amount of your expected refund, minus any associated fees and interest. Once your tax refund is processed, the funds are directed to the lender to repay the loan. The convenience factor is undeniable, but the financial implications warrant a closer examination.

Instead of RALs, Consider These Alternatives

RALs aren’t a smart financial move for most Americans. Rather than signing for a refund anticipation loan, explore these alternatives:

  • Electronic Filing with Direct Deposit:  File electronically and choose direct deposit for a faster, safer refund (often within 3 weeks).
  • Adjusting Withholdings:  Avoid large refunds by adjusting your withholdings, giving you access to more income throughout the year.
  • Earned Income Tax Credit (EITC) & Advance Child Tax Credit: Explore these valuable credits that can boost your refund or reduce your tax liability.

Tax Payments with Credit Cards: Proceed with Caution

Not getting a refund this year? You might need to pay with a credit card if you don’t have enough cash on hand. If you’re in this situation, approach the process with caution.

It might seem convenient or even rewarding to pay taxes with your credit card, thanks to the possibility of earning credit card rewards. Sometimes, though, this method comes with processing fees—typically around 2% of your payment. These fees can easily offset any rewards you may earn, making it a costly option.

If you decide to proceed with paying taxes via a credit card, keep these tips in mind:

  • Choose a Card with a High Rewards Yield: Ensure the rewards you earn will exceed the processing fee.
  • Pay Off the Balance Immediately:  Avoid interest charges by paying off the balance before the due date.

Need Debt Advice During Tax Time? Reach Out to NFCC Today

When it comes to managing your debt and improving your financial wellbeing, informed decisions make a difference. While options like tax refund anticipation loans and paying taxes with a credit card present themselves as convenient solutions, they may not always be right for you, especially if you are struggling to repay the debt you already owe. The National Foundation of Credit Counseling (NFCC) can help.

As the largest and longest-serving nonprofit financial counseling organization in the U.S., NFCC and our partner credit counseling agencies provide help for Americans struggling with financial uncertainty. If credit card and other unsecured debt is already a challenge as you face the prospect of owing taxes, reaching out to NFCC first is a wise step. Call us today at (800) 388-2227, and let’s work together to create a roadmap for your financial future—one that takes you through tax time and beyond.