People don't often think about how credit cards and taxes can work hand-in-hand. Credit cards can sometimes help, or hurt, you during tax time. Here at WhizWallet.com we have outlined everything you need to know about credit cards and taxes, from the best ways to handle a refund to the way the IRS treats credit card rewards.
The deadline to file taxes is April 18 and to help you get through tax season, here are some facts about credit cards you should know:
1. Pros & Cons of Paying the IRS with a Credit Card
The US tax laws forbid Uncle Sam from directly accepting credit cards, so the federal government has sourced that option to third-party services. These services charge a convenience fee ranging from 1.87% to 2.49% of the total payment. Although using a credit card will buy you time until you can pay off your balance. And you can buy more time by taking advantage of 0% balance transfer cards which saves you money on interest. Compare credit card fees with IRS installment payment method before making a final decision.
2. You Can Deduct the Fee for Paying Taxes by Credit Card
The IRS has decided that taxpayers who use credit cards to pay for their federal tax bills need a break. To take advantage of this break, the fee must be counted as a miscellaneous deduction under job expenses.
3. Apply Your Tax Refund to Your Credit Card Debt
First ask yourself where your refund is going to do the most good. If reducing your credit card debt is the most beneficial thing for you, then do some research before applying your refund. Which card should you pay off first? Pay off the highest interest cards first. You need to be prepared to do something about breaking the cycle in the future so that you don't find yourself in the same spot as before. Budgeting apps like Mint are a hand tool to help plan and get a better idea of what the numbers look like.
4. Getting Your Tax Refund on a Prepaid Card
Most people who choose the option to be paid by prepaid card don't usually have a bank account. This option has its advantages, you get your money much quicker than a traditional check, usually within 10 days. This also eliminates the possibility of your check being lost in the mail. The prepaid card method avoids the check-cashing fees which are usually $5-$10, or a percentage of the total.
5. How to Apply Tax Refund to Multiple Card Balances
Reducing or eliminating your credit card debt will surely lower your credit utilization ratio which in return will positively affect your credit score. Instead of applying your entire refund to a single card your best option is to spread them out amongst multiple cards to reduce all their utilization percentages so that none remain in the danger zone. The distribution should occur based on the credit limit and balances. Combined new balance divided by your credit limit is your utilization ratio. Try and even those out across all your cards for maximum effectiveness to your scores.
6. How IRS Treats Credit Card Rewards
The Internal Revenue Service treats credit card rewards and miles like coupons or rebates, not like income or expenses. Since you most likely earned the rewards through some sort of purchases, the IRS considers them rebates which are not taxable. According to tax law, these are considered a sort of discount and not a gain in income or wealth.
7. Forgiven Debt is Taxable
Debt that is forgiven or negotiated down is a huge sigh of relief for most people. However what you may be unaware of is forgiven debt is still considered as income in the eyes of the law. The only exceptions are if the debt was discharged in bankruptcy, mortgage debt due to foreclosure, insolvent debt, or student loan forgiveness. If you receive a 1099-C but qualify for one of these exeptions, you can provide the IRS with an explanation for why you don't need to include the forgiven debt as income - File form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, along with your income tax form.