As unpleasant as the idea of handing over your hard-earned cash to the government may seem, your taxes ensure the availability of government benefits and services, such as public schools and serviceable roads. For those who overpay, tax season brings with it a welcome refund. If you fail to pay the total amount you owe, however, you're left facing a tax debt. The government takes tax debts seriously and leaving your taxes unpaid carries severe consequences. Credit damage is one such consequence.
When you don't pay a commercial debt, such as a loan obligation, your lender reports the missed payment to the credit bureaus. This is not the case with government entities like the Internal Revenue Service. A tax debt is no cause for immediate panic since federal law prohibits the government from reporting your tax debt to the credit bureaus.
If you don't make arrangements to resolve your tax debt, however, your state and federal governments have the right to file a tax lien against you. A tax lien gives the government the right to seize your assets in lieu of payment. Unlike the tax debt itself, a tax lien is a public record. As such, it will appear on your credit report and count against your credit score.
Damaging credit entries generally don't tarnish your credit history forever. The majority of negative information falls off your report after seven years – regardless of whether or not you pay the debt. According to the Fair Credit Reporting Act, paid tax liens follow this rule and disappear from your credit record seven years after the date you pay off the debt. Unpaid tax liens, however, do not have a preset reporting period. If you don't make arrangements to pay the tax debt, the tax lien will remain a part of your credit history indefinitely.
The effect a tax lien has on your credit score varies depending on your credit history. While the exact scoring formula is a secret, the general rule is: the higher your credit, the more negative entries hurt you. A lower credit score makes it harder to qualify for low interest rates and other financial services. Your damaged credit makes you a higher financial risk for companies that do business with you, and these companies can request that you pay a deposit for such services as cell phone activation and utilities.
The best way to avoid the consequences of a tax lien is to avoid the tax lien itself. Because state and federal governments do not report your debt to the credit bureaus, you can protect your good credit rating by making immediate arrangements to pay your delinquent tax debt
If you don't have the income necessary to pay your debt in full, that doesn't mean that you have to resign yourself to a tax lien and the credit devastation that follows. The IRS provides payment plans for consumers who owe back taxes. State governments generally offer similar services – allowing you to resolve your tax liability over time while protecting your credit score.
- Bankrate.com: Should Tax Debt Go On Credit Reports?
- Federal Trade Commission: The Fair Credit Reporting Act (Section 605/p.22)
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