Credit Card Tax Payment Fees

Wednesday, March 28, 2007

Credit card companies are aggressively promoting the use of credit cards to pay personal income taxes. Some companies are offering temporary incentives (like extra mileage rewards) for doing so. Uncle Sam doesn’t mind: the Internal Revenue Service (IRS) received about 2.1 million card payments in 2006, an increase of 35% from 2005. But if you choose to pay your income taxes with a credit card, a surcharge of 2.49% will be added. (Companies are forbidden from adding surcharges to credit card payments, but the credit card banks made a special exception for the IRS).

So, given the 2.49% fee, is it ever worth it to pay your taxes with a credit card? No—adding your tax payment to a revolving credit card balance is a risky and expensive proposition, and you’d be better off repaying through the IRS. The IRS charges an 8% interest rate for underpaid taxes, while the average credit card costs almost twice that much if you don’t pay your balance in full each month.

How about rewards cards? Assuming you paid off the balance right away, is there a rewards card that could make this offer advantageous? You can rule the “convenience checks” credit card companies send. They won’t build up rewards, and usually come with a 3% “cash advance fee.”

In the past, some cards like MBNA’s legendary “HGW1” card from 2004-05, which offered 10% cash back for the first year, would have made this an attractive deal for those with very modest tax burdens (the card had a cap on rewards). But there is no credit card that currently offers a reward to offset the 2.5% fee.

Chase is aggressively promoting the use of credit cards to pay taxes. Chase’s United Mileage Plus VISA offers “double miles,” for federal tax payments, but only for the first $2,500.

People obsessed with frequent flyer miles often value them at 1¢ per mile, which seems reasonable, especially since airlines are making miles increasingly tough to redeem. So, the Chase/United offer would allow you to buy miles at 1.245¢ per mile for the first $2,500, and 2.49¢ per mile on amounts above $2,500. Either way, it’s not cost-effective to buy the miles. There are cheaper and easier ways to obtain frequent flyer miles.

So, what about cash back credit cards? Attractive cash back cards are American Express Blue Cash (after your first $6,500 of spending) and Fidelity Investment Rewards (if you have a Fidelity bank account). They offer 1.5% cash back—but even with these cards, you’re losing 1% of every dollar you spend by paying your taxes with plastic.

Some communities allow homeowners to pay their property taxes by credit card without incurring a fee, although once mortgage companies began gaming the system, these programs have been cut back.

Bright minds might ask if the 2.49% credit card fee is tax-deductible? Unfortunately, the IRS has ruled that it is not. (Credit card rewards are not currently taxed.)

Bottom line: For now, there is no credit card on the market that makes it worthwhile to pull out the plastic to pay your taxes.

What is your Fee of the Week? E-mail us at the Hotline.