How Do Taxes Affect My Credit?

How Paying Tax Can Affect Your Credit Score
How Paying Tax Can Affect Your Credit Score

When you are focused on improving your credit, paying on time and avoiding high amounts of debt will help you build a great credit rating. If you are not paying your taxes, or you use personal loans or credit cards to pay your taxes, your tax bill is something that could have a devastating impact on your credit rating. Missing a deadline for tax payments to the IRS could even result in a tax lien.  Here are some ways taxes can affect your credit:

What is a Tax Lien?

If you fail to pay your taxes, the IRS can file a federal tax lien with the credit bureaus. This will dramatically impact your credit rating. The IRS usually files a lien if you owe more than $10,000 and you have not paid for at least 30 days. If you end up with a lien from the IRS, you can end up with 100-point hit to your credit rating; enough to take your score from good to poor and significantly affect an individual’s financial history.

IRS Payment Plans

The best way to avoid a tax lien is to pay your taxes on time. If you do fall behind, one option the IRS provides is a payment plan for individuals to pay their taxes. The IRS will automatically debit your account each month until you have paid off the entire balance owed. If you enroll in the payment plan, you can have the lien removed by asking the IRS to take it off your credit report. Payment plans with the IRS will not reflect on your credit rating, but if you are late with payments to the IRS, they can reinstate the lien which will then negatively affect your credit.

Personal Loans

Some people choose to take out a personal loan to pay their back taxes. If you decide to go this route to pay your taxes, keep in mind that you will need to pay interest on the loan which could compound and result in a much higher total owed depending on the interest charged. To be approved for the loan, you must meet the credit requirements of the lender. When they pull your credit report, a failure to pay your taxes will appear on your credit report, which will affect the interest rate at which a loan is extended to you or even prevent you from getting a loan at all. If you are late to make payments, your credit rating will be impacted. Defaulting on the loan, like failing to pay your taxes, will drastically hurt your credit score. That said, the interest from an IRS installment plan may accrue more quickly than the interest on a loan. Carefully consider if using a personal loan to pay your taxes is the best decision, and consult with an R&G Brenner tax professional if you need help deciding what would be right for you.

Credit Card Payments

Another way your tax bill can impact your credit rating is if you use a credit card to pay your taxes. Credit cards come with certain interest rates, which can increase your debt burden. The interest of a credit card can end up causing you to pay more money than you initially owed in taxes. Like a personal loan, missing payments on your credit card can hurt your credit score. Credit cards add to your debt burden, which can hurt your credit rating if you end up borrowing too much. Having a high balance on your credit cards can even prevent you from raising your credit score. If your credit rating is severely impacted, you can have a hard time getting approved for other loans, and it can even hurt your ability to find a job.

R&G Brenner usually suggests taxpayers try to take advantage of payment programs offered by the IRS, before other options as they usually are the most beneficial to the taxpayer.  However, it is important to consider all different options available when paying your taxes so taxpayers do not end up unnecessarily struggling with higher amounts of debt.

What California and Kansas Can Teach Us about the Laffer Curve and Tax Theory

The Real Laffer Curve?
The Real Laffer Curve?

Since the economic collapse that began in 2008, politicians and lawmakers all across the United States have been on the move to enact policy that will stimulate the economy and bring back jobs. Tax policy has inevitably become part of this national discussion. The Laffer Curve, an economics theory that posits that cutting taxes is beneficial for economic stimulation, has been put to the test in two real life scenarios that have played out in Kansas and California. The results provide significant evidence that calls into question the well-worn principle that a higher minimum wage decreases overall employment and income.

Arthur Laffer’s Theory

The Laffer Curve, one of the fundamental tenets of supply-side economics, was popularized by the economist Arthur Laffer in the late 1970s. As a curve, it merely demonstrates the relationship between tax rates and total tax revenues collected by the government. According to this construct, the effect of a lower tax rate is an increase in work, output, and employment whereas a high tax rate penalizes these activities. The curve is often used to explain and justify the pro-growth worldview of supply-side economics. It should be noted, however, the Laffer Curve does not say definitively that a tax cut will raise or lower revenues. For example, a tax rate of 100% wouldn’t collect more money than a rate of 25%, as no one would be willing to work for an after-tax income of $0. The value of the Laffer Curve is its ability to predict economical behavior based on simple arithmetic truths.

Kansas Tax Cuts & California Tax Hikes

In the case of Kansas, after the election of Sen. Sam Brownback as governor in 2010, the state rolled out a new tax policy, a virtual low-tax paradise that was eventually meant to eliminate the state income tax. Brownback’s administration consulted Laffer on tax cuts and enacted these measures in the hopes that, according to the Laffer Curve, they would help to fuel the stagnant economy. The measures, called “the largest tax cut ever” at the time, were enacted in 2012. It quickly became clear that Kansas’ economy was not following the upward trajectory the Laffer Curve predicted it should. As a result, the state’s credit rating was lowered, first by Moody’s Investors Service and later by Standard & Poor’s, who cited “a structurally unbalanced budget.”

Meanwhile in California, tax rates were rising as much as 30 percent, raising the sales tax to the highest in the nation at 7.5 percent. The Laffer Curve indicates that California’s job growth should have slowed to a crawl and brought the state’s economy to a grinding halt. This October Governor Jerry Brown was happy to announce that the measures had quite the opposite effect, stating “California is back.”

Contradictory to what proponents of the Laffer theory may have predicted, it was California that came out the winner. Jobs in the state grew at a rate 3.4 times greater than in Kansas, and non-farm payroll jobs increased 7.2 percent in California compared to just 2.1 percent in Kansas. California’s credit rating also improved, unlike Kansas’, which means that the state can borrow money at much lower rates than Kansas can. So what happened? Do these real-life contradictions mean that the Laffer Curve doesn’t work?

What Real Life Contradictions Mean

No economic model is perfect. If anything, what these real world contradictions tell economists is that their models need more refinement, but it sends a message to politicians as well. The real world will always trump theory, and changes in policy would be better based on actual data about the number of jobs and what they pay rather than projections, ideology and theory.

It could be that raising the minimum wage will, in the fullness of time, lead to different results. California’s economy could still collapse, and Kansas could see the job growth its experts hoped for originally.  Kansas may fall behind yet further with their frozen minimum wage. For now, it would be wise of policymakers to look at the results and take note. No theory, however compelling, should be more persuasive than real-life results.

5 Tips for Avoiding an IRS Tax Audit

Tips To Avoid An Audit
Tips To Avoid An Audit

IRS audits are feared for good reason: at best, they’re disruptive, and at worst they can cost you vast amounts of money. Though the percentage of audited returns is relatively low, every year the IRS still audits a huge number of returns. Following these tips can help you reduce the chances you’ll end up as one of their targets. 

Be Diligent With Business Deductions

This primarily pertains to the self-employed and business owners. While it may be tempting to write off your apartment as a home office or your car as a business investment, the IRS has careful formulas for determining whether or not particular expenses are deductible. For instance, only the part of your home used exclusively counts towards the home-office deduction—meaning writing off too much square footage could get you noticed. Car expenses, likewise, must be carefully calculated. If you’re thinking of writing something off,  you should do some research or contact a tax professional.

Keep Everything

No, not “everything” as in money. “Everything” here means documentation, like receipts, pay stubs, leasing agreements—really, anything that might be slightly relevant during tax time. Tax returns gets much more difficult to complete when you’re missing documents–and complications could lead to you miscalculating a deduction or forgetting to declare an income source. And, in the unfortunate event of an audit, you will need all of your documentation to verify your deductions.

Choose Your Professional Wisely

Many people, especially those with complicated tax situations, hire tax professionals to help take the headache out of tax season. But according to MSN Money, choosing the wrong tax “pro” can be disastrous.  So, when picking a tax preparer, check out their track record, customer reviews, how long they’ve been in business, their Better Business Bureau standing—just do your homework, as you would when hiring any other type of professional.  R&G Brenner currently has an A+ Rating with the BBB

Pay Quarterly Taxes (If Necessary)

If you’re self-employed, the IRS expects you to keep up with your tax obligations throughout the year. This means not only filing an annual return, but also paying quarterly taxes if a certain proportion of your income comes from self-employment. It’s especially vital for the self-employed to keep up with their taxes because they have no employer withholding income taxes or chipping in on Medicare and Social Security taxes. Some tools you can use to keep up with your quarterly taxes are Form 1040-ES, which can help you determine if you need to pay quarterly taxes, and the Electronic Federal Tax Payment System, which you can then use to pay quarterly taxes. 

Electronically File

Depending on the system you use, electronic filing (e-filing) can have several advantages: less paperwork cluttering your desk, easy deduction-tracking systems, built-in calculators, and so on. But perhaps the biggest advantage is that, according to the IRS, e-filed returns have an error rate of only 1%, compared to 20% for paper returns. And if there is an error, e-filed returns can report back to the sender much more quickly, hopefully allowing them to correct the problem.  Furthermore, the IRS & states like NY require all tax returns to be e-filed unless you have a legitimate excuse for not filing electronically.  If they don’t like your excuse, they can fine you.

These tips are general, but every taxpayer’s situtation is unique. For more help, the IRS website—while sometimes complex—has resources for just about all tax situations. You can also talk to an R&G Brenner qualified tax professional to help you navigate the nuances of the tax code.