Does Filing Taxes Affect Your Credit Score?
Learn the indirect ways taxes can affect your credit. While filing isn't reported, how you manage a tax bill or debt can impact your financial health.
Many people wonder about the connection between their annual tax obligations and their credit health. Since the process of filing taxes, paying what is owed, and receiving refunds involves significant financial activity, it is natural to question its effect on credit scores. Understanding this relationship requires looking at what information is shared between tax authorities and credit reporting agencies.
The Direct Relationship Between Tax Filing and Credit Scores
Filing your annual income tax return does not directly affect your credit score. The Internal Revenue Service (IRS) does not report your tax filing status or payment history to the three major consumer credit bureaus: Equifax, Experian, and TransUnion. Therefore, scoring models like FICO and VantageScore do not include data from your tax returns in their calculations.
Whether you are due a refund or owe a balance has no bearing on the factors that determine your score. These models are primarily concerned with your history of managing debt obligations, such as loans and credit cards. Your payment history, the amounts you owe, and the length of your credit history are the drivers of your score, not your interactions with the IRS.
Your income, as reported on your tax return, is also not a component of your credit score. While lenders will ask for income information when you apply for a loan to assess your ability to repay, this is separate from the data held in your credit file. The act of filing a return is a private matter that is not reflected in your credit history.
When Unpaid Taxes Can Impact Your Credit
The situation changes when a tax debt goes unpaid. If you fail to pay your taxes and the debt remains unaddressed, the IRS can file a Notice of Federal Tax Lien in the public record. This lien is a legal claim against all your current and future assets, such as real estate and personal property, securing the government’s interest in the debt.
In 2018, the major credit bureaus removed all tax liens from consumer credit reports. This means a federal tax lien will no longer appear on your credit reports from Experian, Equifax, or TransUnion and will not directly lower your credit score.
Even though a tax lien is absent from your credit report, it remains a public record. Lenders, especially for mortgages, frequently conduct public record searches as part of their underwriting process. Discovering a tax lien can signal financial risk to a lender, hindering your ability to secure a new loan, even with a high credit score. The IRS will release the lien within 30 days after the debt is paid in full.
Paying Your Tax Bill With Credit
Paying your IRS tax bill with a credit card can influence your credit score. The IRS does not accept direct credit card payments, instead using authorized third-party payment processors. These companies, such as ACI Payments, Inc. and Pay1040, charge a processing fee for their service.
These convenience fees are a percentage of the total tax paid, often ranging from 1.75% to 1.98% for personal credit cards. For example, a 1.85% fee on a $5,000 tax bill would amount to an additional $92.50. This payment is treated as a standard purchase on your credit card statement, not a cash advance.
The primary impact on your credit comes from how the charge affects your credit utilization ratio. This ratio measures the amount of revolving credit you are using compared to your total available credit. Charging a large tax payment can cause a sharp increase in your utilization, a major factor in credit scoring, which can lower your credit score until the balance is paid down.
Tax Refunds and Your Credit
Receiving a tax refund does not have a direct impact on your credit score. The IRS issuing a refund is not a credit-reportable event, and the credit bureaus are not notified of the transaction. The refund itself is a neutral event in the eyes of credit scoring models.
The benefit to your credit comes from how you choose to use the refund money. For instance, using the funds to pay down high-balance credit cards can lower your credit utilization ratio, which can positively influence your score.
You can also use a refund to address negative items on your credit report, such as bringing past-due accounts current to stop further late payment reports. Using the money to build an emergency fund can also provide a buffer against future financial shocks, preventing you from relying on credit and potentially missing payments.