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If you find every excuse to use a credit card to reap reward points, it might be very tempting to use it to pay a big tax bill.
You wouldn't be alone. Last year, 1.57 million people paid their taxes by credit card, 54 percent more than the year before, the Internal Revenue Service said. As many as a third of them did it just to accumulate points, says Official Payments, one of two companies that process the credit card transactions for the government.
Are you even more tempted? It's absolutely ludicrous to use your credit card for taxes to rack up points.
THERE IS NO FREE LUNCH AND DIRTY LITTLE SECRETS
Here's why. The two companies that process credit card payments for the I.R.S. the other one is Link2Gov by agreement with the I.R.S. extract a 2.49 percent "convenience fee" from taxpayers to both cover the merchant fee that the credit card company charges and to make a profit.
Since few reward cards pay more than a 1 percent cash reward, you'd be in the hole if you paid by card. That is, unless the credit card company pays your convenience fee, as Discover is doing.
It doesn't make much more sense to pay by credit card just to get airline mileage reward. The numbers will vary from one program to another, but here's how to think about it using the Chase Value Miles Platinum Visa as an example. You receive one point for every dollar spent and it takes a minimum of 24,000 points for a domestic airline ticket.
So to get one ticket, you'd have to pay a $24,000 tax bill. (You'd have to have an unusually high credit limit to pull this off, but just play along with this thought experiment.) It would cost you the 2.5 percent convenience fee or, in other words, $600. Ask yourself this: How often do I buy a $600 advance-purchase ticket to travel inside the United States? The chances are, you'll lose on this deal.
What if the credit card companies sweetened the offer? Chase is doubling the miles for each dollar of taxes paid on its United Mileage Plus Signature Visa card, and American Express is doing the same for its Delta and Starwood credit cards. It's starting to feel like "Deal or No Deal."
You'd get a ticket for $298. It pays to look for the deals and if you go for this one, read the fine print first. The card companies pile on numerous restrictions. Of course.
H&R Block is trying to encourage taxpayers to use the online version of its TaxCut software with an offer of an $8.49 rebate if you use a MasterCard debit card to pay your taxes. Link2Gov waives the fee for users of debit cards, though such cards rarely have rewards programs. (Link2Gov is at pay1040.com or 888-658-5465. Official Payments can be reached through officialpayments.com or 1-877-754-4420.)
If you want to avoid the middleman's convenience fee you might pay with those convenience checks that come with your credit card statement. The fee for their use could be slightly lower; they vary from 2 percent to 4 percent.
Paying by credit card is dangerous for anyone who doesn't pay off the balance each month. The high interest rate that most credit cards levy on debt will make it mushroom. Rewards cards generally charge higher interest. That Chase card, for example, charges 12.24, 16.24 or 20.24 percent depending on your credit score. How long will it take you to pay off $3,000 when your card charges 12.25 percent and you pay $150 of that debt each month? You'll be free and clear in 2008 after paying a total of $3,373. Owe next you, and you’ve bought the farm.
If you pay off the minimum 2 percent, it would take you 21 years to pay it off. (A Web site that can do this truly terrorizing calculation can be found at www.maedastudio.com/2006/credit/index.php.)
If you are in that situation, transfer the balance to the card with the lowest interest rate. Another way out, if you know in advance that you won't be able to pay your taxes, is to ask the I.R.S. if you can pay it in installments. You have to fill out an application (Form 9465, found at the I.R.S. site www.irs.gov/pub/irs-pdf/f9465.pdf); if approved, you are put on a payment plan of three to five years. The setup fee is $43 and the interest rate, which changes every quarter, is currently 7 percent with a failure-to-pay penalty of 0.25 percent a month. (If you owe more than $25,000, the process and the penalty is more taxing.)
The I.R.S. quite firmly advises against the installment plan option and says a lump-sum payment is far better.
“A more favorable solution to resolve the debt would be to obtain a loan from a bank or other financial institution, or pay taxes using a charge card," it says. Of course, the I.R.S. would say that because it prefers to have cash in hand than an accounts receivable. Nevertheless, the agency is correct. Because of those failure-to-pay penalties, you'd be better off paying with a card charging 10 percent.
BUT THERE IS THE BANKRUPTCY COURT - RIGHT ?
If you are teetering on the edge of solvency and considering a bankruptcy filing, you might be tempted to pay off your taxes with the credit card. After all, the government stands at the front of the line of your creditors in any proceeding and that debt can't be discharged by bankruptcy. But credit card companies stand at the end of the line with unsecured debt.
Wrong, it won't work. Congress thought of that (with the help of those kind people who send you hundred’s of offers for credit cards) when they wrote the new bankruptcy law. Any tax obligation paid by credit card in the previous three years is not dischargeable through bankruptcy. Whether the credit card company would catch it is another thing, but no bankruptcy attorney would advise you to do this.
Another taxpaying convenience that levies a fee is electronic filing. More than 68 million taxpayers tried this last year, and this year even more will hand over $10 to $15 depending on which of the dozens of government-authorized "electronic return originators" they use. There is no way to send your return electronically to the government except through one of them because the I.R.S. isn't equipped to receive millions of individual returns, most of which come in right before the April 15 deadline. (The deadline this year is April 17 because April 15 falls on Saturday.)
HELP IS AVAILABLE - AND IF YOU’RE CAREFUL, FREE
A savings tip: If your adjusted gross income is less than $50,000, (if you’re Hispanic, the AGI limit is $37,000.00 for locally I.R.S. sponsored tax clinics) you don't have to pay a fee for filing online with tax software. About 98 million taxpayers are eligible for this deal. The catch is that you have to pay the fee for filing a state return electronically or file that return the old-fashioned by very reliable paper way. In Virginia, you can avoid the state return filing fee fee because the Virginia Department of Taxation will let you file for free. Click here for the links for free E-file
What do you get for the fee? Your return is processed more quickly and you get your refund in two weeks, the I.R.S. says. If your money is directly deposited to your bank account and it should be getting it in the bank a month early would make you about $7.30 on a typical refund of $2,500. Remember, we do not charge to have your refund direct deposited, but we, like 1,500,000 other tax professional’s refuse to participate in E-file.
WHY? It also gets you a very fast and close inspection of your return, and an even quicker notice of audit when the I.R.S. computer doesn’t like your return. Too many people rely on the computer for tax returns in our opinion. We saw a new client in February 2006 who E-file’d themselves and did so incorrectly. That cost them over $6,000.00 in needless tax, fines and penalties ! All to save the $90.00 we would have charged them. Since the E-file program went into effect, the I.R.S. and states have seen a windfall in the amounts they received and have been able to assess for fines and penalties much more quickly, because of taxpayer errors. Fact is, all this was taken into account when the E-file program was hatched in Washington. The average taxpayer is honest, but does not know the Tax Code. Recently, the National Taxpayer Advocate (appointed by Congress) articulated that their findings categorically refute the I.R.S. drone that the American taxpayer is generally out to cheat the government.
Software is no substitute to human preparation of tax returns by tax professionals. So, beware what the government sells you.
If you’re hell bent on doing it yourself, another savings tip: The $45 online version of TurboTax for federal and state looks as if it costs more than the identical boxed software costing $40. But the online version gives you online filing for federal and state tax free, so you save $25. The online version of H&R Block's TaxCut Premium tax preparation software is $21 cheaper than the comparable boxed software version and also comes with free electronic filing.
Want to avoid thinking about any of this next year? Then adjust your withholding so you get neither a big tax bill nor a big refund check. There is no virtue in getting a big refund. It just proves you didn't plan wisely and gave the government an interest-free loan. That usually happens because you fill out a W-4 form the first day of work and then forget about it as your life changes.
You can fill out a new W-4 form as often as you need to. But the form is so maddeningly complex that to fill it out with any confidence you may need to ask us (or other competent accountant) to do it for you. Just another lovely way the I.R.S. makes your life less taxiing, NOT!
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