What is a Credit Score?
In simple terms, your credit score is a number between the range of 300 to 850, and it reflects an individual’s creditworthiness to the lender. A higher number will improve your chances of getting cheaper and quicker credit. Every year, different national credit bureaus collect a range of data to come up with an objective credit score. A number of factors, including but not limited to your borrowings and payments in the financial year, credit history, credit mix, and credit utilization may impact your credit score.
Does Tax Debt Impact Credit Score?
Tax is a complicated matter, and most of us have owed some money to the IRS at some point in time. But do you need to worry about your credit score if you owe dollars to the IRS? There is a considerable level of confusion among people regarding the impact of tax debt on a credit score. Let’s look at this factor in detail to understand how tax debt may or may not go on to decide your credit score.
The Answer is No:
Typically, credit scores do not track tax payments or liabilities. In other words, credit scores would not include any record related to whether or not you pay your taxes on time. Even if you are late on your tax payment to the IRS, a typical credit score report would not include it. So, it is safe to say that your tax debt does not impact your credit score on a normal course of business.
However, the Answer Could be Yes:
The IRS has the authority to go to court to secure a federal tax lien against an individual’s property if he or she has failed to pay taxes despite repeated letters and reminders. Before 2018, the federal tax lien used to appear on a credit score; hence, directly impacting the credit score.
Luckily, this practice has stopped since 2018. It means that any information related to tax debt, including federal tax lien, is no longer reflected on credit score. This means that you are pretty much safe even if you have a huge tax debt against you.
At the same time, however, it is also important to mention that this safety may not be absolute. The fact of the matter is that even if you have a desirable credit score, some lenders are in the habit of performing due checks on their own end as well. This could lead to lenders discovering your tax debt (and the corresponding federal tax lien) with the help of public records.
This is especially true in case you are applying for a mortgage or other forms of big loans. Not all but many lenders consider federal tax lien enough cause to deny loan/ mortgage applications.
Similarly, the outstanding tax debt can have an indirect impact on your credit score. Many people choose to pay outstanding tax debt with the help of a credit card or an extended line of a personal loan (both of which have high-interest rates). While your tax debt is not reflected, this credit or loan shall be reflected in your credit history and may go on to hurt your score.
Moreover, since you’ll be paying a high-interest rate on this line of credit, it may also go on to impact your financial well-being and financial goals in the near future.
The Bottom Line:
The fact of the matter is that there is no direct link between your current tax debt and your overall credit score, as no information related to tax payment is used in credit score calculation. However, lenders still have a number of ways to know your tax debt, especially the federal tax lien by the IRS. Moreover, the outstanding tax debt can indirectly affect your credit score or financial well-being in the long run. Hence, it is always recommended to ensure timely payment of your taxes.