Why You Should Pay Off IRS Tax Debt Before Credit Card Debt

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Debt is a burden that millions of Americans face, and managing it effectively is crucial for financial health. When balancing multiple obligations, such as tax debt owed to the IRS and credit card debt, many people may wonder which to prioritize. While both types of debt can have significant consequences if left unpaid, tax debt should typically be addressed first for several compelling reasons. Here’s why you should prioritize paying off your IRS/tax debt before tackling credit card debt:

• The Power of the IRS to Collect Debt

The IRS has far greater power to collect debt than credit card companies. The government can take aggressive actions to recover unpaid taxes, including:

• Wage Garnishment: The IRS can garnish your wages without a court order, meaning a portion of your paycheck will automatically go toward paying your tax debt until it’s settled.
• Bank Levies: The IRS can seize money directly from your bank account to cover your outstanding tax balance.
• Liens and Levies on Property: If you owe the IRS, they can place a lien on your home or other valuable assets, making it difficult to sell or borrow against them.

In contrast, credit card companies must go through the courts to garnish wages or seize assets, which gives you more time and leeway to negotiate or settle the debt.

• IRS Penalties and Interest Accumulate Rapidly

Tax debt grows faster than credit card debt due to the steep penalties and interest rates the IRS imposes. If you fail to pay your taxes on time, penalties can add up to 25% of your balance over time, and interest continues to accrue daily.

For instance, the Failure to File Penalty can be as high as 5% of the unpaid taxes for each month the return is late, while the Failure to Pay Penalty is 0.5% of the unpaid taxes each month. These costs can quickly multiply the amount you owe, making it critical to deal with your tax debt promptly.

• The IRS Offers Fewer Leniency Options

Credit card companies often offer flexible solutions for debt management, such as lowering interest rates, offering settlement plans, or even forgiving part of the debt. While negotiating a lower payment or a debt settlement with credit card companies is more common, the IRS tends to be less lenient.

While the IRS offers Installment Agreements and Offers in Compromise (OIC), they are generally harder to qualify for, and the terms are stricter. Plus, the IRS scrutinizes your financial situation more closely before offering relief, which can make it harder to negotiate favorable terms.

• Avoiding Tax Liens and Damage to Your Credit

Tax liens can severely damage your credit and financial standing. Once a lien is filed, it becomes public record, making it more difficult to secure loans, open lines of credit, or even get favorable interest rates. While both tax debt and credit card debt affect your credit score, a tax lien is more damaging because it indicates government involvement in your financial situation.

Additionally, a lien can make it impossible to refinance or sell property without first paying the IRS. In comparison, credit card debt, while damaging to credit scores if unpaid, doesn’t automatically trigger such serious consequences as liens.

• Difficulty in Discharging Tax Debt in Bankruptcy

If you’re struggling with a heavy debt burden, bankruptcy may be an option to consider for wiping out credit card debt. However, tax debt is notoriously difficult to discharge in bankruptcy, particularly recent tax debts. There are strict guidelines that must be met for tax debts to be forgiven through bankruptcy, and even then, it’s often not possible.

In contrast, credit card debt is generally easier to eliminate in bankruptcy proceedings. This makes it more important to pay off tax debts first, since they’re less likely to be relieved in the event of a financial crisis.

• Legal and Criminal Consequences

Failure to pay credit card debt can result in legal action from creditors, but it rarely leads to criminal charges. However, failing to pay your taxes could, in extreme cases, result in criminal charges for tax evasion or fraud. While this is rare and typically reserved for those who willfully avoid taxes, it’s a risk that should be avoided by staying current on your tax payments.

• Payment Plans and Negotiation Options

The IRS does offer payment plans, known as Installment Agreements, which allow taxpayers to pay off their tax debt over time in monthly payments. Though interest and penalties still accrue, these plans provide breathing room, helping taxpayers avoid immediate, aggressive collection actions like liens or levies. On the other hand, credit card companies typically offer higher interest rates and may not provide structured repayment plans with the same level of flexibility.

Conclusion

While it’s important to manage all forms of debt, tax debt should be your first priority because of the aggressive collection actions the IRS can take, the rapid accumulation of penalties and interest, and the legal implications of unpaid taxes. Credit card debt can usually be negotiated or delayed without the same level of consequence. By paying off your IRS/tax debt first, you protect yourself from harsher financial and legal consequences, giving you more room to deal with other forms of debt.

In short, prioritizing tax debt keeps the IRS at bay and allows you to focus on managing and eventually eliminating other financial obligations, like credit card debt, on your own terms.