How Taxes Affect Your Credit
Owe money to the IRS? You could lose your home, your car and everything else. But there is a way to handle your tax debt, keep all your stuff and hide your debt from almost everyone – including the credit bureaus.
The key is written in the IRS tax laws.
Privacy laws prohibit the IRS from contacting national credit agencies when you don’t pay your taxes. That gives you a window of time to handle the problem discreetly.
Wait too long to deal with your debt, and it gives the credit bureaus more time to find out. That can only hurt your ability to get back on your feet.
When you don’t pay your taxes, the IRS begins the collections process immediately. Late fees are added. Interest rates compound daily. Your tax bill escalates every day until the IRS gets paid.
At this point, you have a few choices if you want to keep your tax debt private. You can challenge the debt, sign up for installment payments or pay it off immediately.
As long as you are working with the IRS, they will give you time to pay off the debt without anyone knowing. All that changes if you ignore the notice or default on payments.
Federal tax lien.
If you owe the IRS more than $10,000 and fail to take action within 10 days of the notice, a federal tax lien is automatically triggered.
The IRS can’t notify credit bureaus, but they do notify state and county offices, as well as your creditors, that they have a claim against your property.
Since credit bureaus review public records, it is only a matter of time before they find out.
However, the credit bureaus will only know the amount of the tax debt when the lien is filed. They will not know if it grows due to fees and interest, and they will not know if it shrinks as the debt is paid down.
That will hurt your credit as long as it remains on your report.
Until recently, a tax lien stayed in the public record for seven years after it was paid off.
Starting in 2011, the IRS began the Fresh Start initiative to let taxpayers petition to have the lien withdrawn from the public record 30 days after the debt was fulfilled.
The IRS also allows taxpayers to have the lien removed from public record before the debt is paid off.
However, you need to set up a direct debit agreement to automatically deduct monthly payments from your bank account or paycheck and schedule to pay it off in five years.
Unfortunately, removing the lien from the public record doesn’t automatically take it off you credit report.
You will have to fill out Form 12277 and ask the IRS in writing to notify all three credit bureaus to reflect that the tax debt has been paid and the lien removed.
“A tax debt can damage your
finances in the long term.”
A notice of levy.
Once the IRS decides to levy your assets to pay off your tax debt, they can seize your bank account, garnish your wages, take your car and sell your home.
What’s worse, they notify all your creditors that they seized your property and you will still owe any outstanding balances. That’s like an atomic bomb for your credit score.
A levy on your credit history downgrades your credit worthiness and turns you into a high-risk debtor. That can make it difficult to get a loan for a car and low interest rates on a credit card.
Plus, a levy stays on your credit history for seven years after you pay off your tax debt, making it very difficult to rebuild.
If you borrow to pay the IRS.
The IRS acknowledges its fees and interest rates are high and even suggests taking out a cash advance or loan to pay off your tax bill.
A bank loan will show up on your credit report like any other loan, changing your credit utilization ratio, which is the percentage of money you owe compared to the amount you could owe if you max out all your credit lines.
However, it’s better to have a high credit utilization ratio than to have a levy on your home. Just be sure to make payments on time to keep from getting additional hits to your credit.
A tax debt can damage your finances in the long term, hurting your credit and ability to recover. If you don’t avoid the debt and address it quickly, you may be able to keep your credit intact.
Photo source: carlanthonyonlinedotcom.wordpress.com.