Taxpayer First Act Credit Card Trap

President Donald Trump signed the Taxpayer First Act on July 1, 2019. The Taxpayer First Act has a number of provisions, some of which will help IRS with its internal processes, and some of which are external and aspirational. As to one of the provisions, the IRS is about to embark on a relationship with credit card companies to allow taxpayers the ability to pay their taxes directly by credit card. As you may or may not be aware, one major possibility for a taxpayer to favorably resolve solve their IRS debt, when conditions permit is via bankruptcy. A resolution requires use of the 3-year, 2-year & 240 day limitation provisions with tolling.

Bankruptcy Code §523(a)(14) states that if a nondischargeable tax debt to the United States ( such as a nondischargeable tax or a customs duty) then any credit card debt incurred to pay such nondischargeable tax debt is excepted from discharge. As a practical matter this has been the rule for some time, but the possibility of paying federal tax debt directly with credit cards is expected to have a “short circuiting” effect, exposing what was has otherwise been an obscuring relationship between the credit card borrowing and its traceable application directly to a tax debt.

Currently, the use of credit cards to obtain money for use in paying taxes is difficult to trace because it probably involves a borrowing mechanism that uses currency as an intermediate, such as with an ATM machine. Only a few services allow transfer directly from credit card into a bank account, but the fees range from 10%-15%. Over the next few months, the IRS may be able to negotiate credit card transaction fees to 1-2% (not including interest). If and when this occurs, the use of direct credit card payment to the IRS will the greatly preferred in instances where credit cards are used as a source of tax payment funding.

This also will probably mean that tax transcripts can be expected to carry some indication to reflect the fact that a tax payment was accomplished with a credit card. Whether this indication shows up in taxpayer transcripts or is available internally at IRS, the tracing to verify the type of payment should be expected to be easy. Because the charging taxpayer is going to have to pay a publicly known credit card processing fee the records of the transactions may be even more identifiable in the bank credit card records, especially if the user fee is independently posted. In short, the fact of the direct use of a credit card to pay tax debt should be instantly and unambiguously available to both the IRS insolvency unit and to the credit card account creditor.

The combination of direct credit card use and an expected low initial transaction fee should make this option very popular, but once the option is used, it will work to the detriment of tax debtors and shift the possible remedy chosen as between bankruptcy, offer-in-compromise, and other alternatives. Worse still, if tax debt practitioners fail to ask about credit card tax payment, or discover and understand it on the account transcript, and take it into account for an analysis of the debtor’s options, unpleasant surprises will result. Also needed is a warning advisement to avoid the direct use of credit cards to pay tax debt as soon as possible, starting before this mechanism is fully implemented.


Published by taxdebtapproach

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