Staying in Uncle Sam’s good books and maintaining a healthy credit score are two solid goals for any business owner. Have you thought about how the two things relate?
For the most part, your credit score and taxes are unrelated, but how you handle your tax obligations could affect your credit reports – both personal and business. This means that your ability to secure business financing and negotiate favorable terms with suppliers, landlords, and so on, can be affected by how you have handled your taxes in the past.
Here are three ways in which your taxes can affect your business and personal credit score.
1. Using Credit to Pay Your Taxes Could Come Back to Bite You
Have you ever forgotten to pay your self-employment tax, or underestimated your quarterly estimated payments? If so, you may find yourself the recipient of an unexpectedly large tax bill. This alone won’t hurt your credit score. However, the way you choose to pay that tax bill could, especially if you choose to pay by credit card or take out a loan.
Consider the following scenerios:
- The Perils of Paying off Tax Debt with a Credit Card – If you’re maxing out the credit on your card regularly, charging a tax bill to it could hurt your credit utilization ratio and result in costly interest charges if you can’t pay your bill off in full each month. You can overcome this by spreading debt out over several cards or transferring debt to a zero percent card. Of course, taking out too many cards comes with credit score ramifications, too. On the flip side, a business credit card can also help you build your business credit.
- Taking out a Business Loan Could Hurt Your Credit Score – When you take out a loan, the lender may pull a credit report inquiry. Banks, and many fintech companies, may require a small business owner’s personal credit score for underwriting. These credit inquiries not only prevent you from keeping your business and personal finances separate, they can also hurt your credit and FICO scores. Lenders use your FICO scores along with other details on your credit reports to assess credit risk and determine whether to extend credit.
Tip: If faced with a large tax bill, contact the IRS and arrange to pay it off in installments. Fortunately, these agreements aren’t reported to credit agencies. If you do need to take out a loan or open a business line of credit, look for lenders whose credit requirements match your credit score or who don’t place exclusive emphasis on credit in making lending decisions. In fact, that’s the Fundbox model.
Fundbox Direct Draw works like a revolving line of credit for small businesses, with limits from $1,000 up to $100,000. Unlike other lenders, Fundbox makes credit decisions by reviewing your business transactions, not your FICO score to get started.
2. Tax-Related Identity Theft Could Burn Your Credit Score
It’s a stressful event when someone uses your stolen Social Security number to file a return in your name and pocket a refund. The good news is that the IRS is making gains in cutting down on tax-related identity theft. According to USA Today, the number of reported cases of identity theft dropped 50% during 2016 with 787,000 confirmed fraudulent tax returns filed, compared to 1.2 million in 2015.
Still, many times, individuals may not be aware that someone has stolen their identity. The IRS may be the first to let you know you’re a victim of ID theft after you try to file your taxes.
While fraudulent returns won’t directly affect your credit report, the fact that your Social Security number has been compromised could expose you to other credit troubles, such as thieves opening credit cards and other financial accounts in your name. Such activity which will almost certainly have an impact on your credit score and your ability to grow your business through financing (remember, many lenders check your personal credit before approving a loan).
Tip: If you won’t be applying for credit anytime soon, you can protect yourself by putting a freeze on your credit reports. You can also invest in a credit and identity monitoring service. Here’s some more information about how to think about credit monitoring services.
3. Tax Liens Get Dicey
A tax lien is automatically imposed by the IRS if you have a business or personal tax bill of over $10,000 and neglect or fail to make the payment. A lien basically states that the federal government has a legal claim against your company’s assets or personal property that it can claim in the event of non-payment.
Until last year this was problematic for your credit score since tax liens were reported to credit agencies and creditors alerted that you’re a risky borrower.
The good news is that all three major credit bureaus – Equifax, Experian and TransUnion – began excluding or removing many liens and nearly all civil judgments from consumers’ credit reports starting in 2017. There is a caveat, tax liens will be left off credit reports if they don’t include the individual’s name, address and either a Social Security number or date of birth. The move is part of a plan to ensure that consumer identifications in the data are accurate and current
The true fall out of this change, as USA Today reports, is still to be determined. Even if liens aren’t reported on credit reports, the new policy could make the screening of potential borrowers more difficult for lenders as they jump through more hoops to gauge a borrower’s credit-worthiness, potentially slowing down the loan application process and resulting in loans being granted to businesses who lack the ability to repay.
Tip: No one wants a tax lien, but you do have several options to avoid one. Options for funding to pay off your taxes include lines of credit, credit cards, or install agreements (the IRS now allows businesses who owe more than $25,000 to participate in a Streamlined Installment Agreement if they pay off their tax bill in two years or less).
Once repaid, the IRS will release the lien within 30-days. Be sure to request a copy of the lien release and contact the credit reporting bureaus like Equifax, TransUnion, and Experian to ensure your business and personal credit reports have no record of it.
Want to learn even more about credit scores? Keep reading:
- Why You Should Really Care About Your Business Credit
- Are you a Credit Risk? What Really Goes into Your Business Credit Score
- 6 Hacks for Building your Business Credit
Fundbox and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.