Some time last quarter, I became a partner of our anesthesia group (hooray!). All of a sudden, I was no longer a W-2 employee who had taxes withheld by my employer. So now as a partner (and not an employee), I have to pay my own estimated taxes every quarter through Form 1040-ES.
At first, I had mixed feelings. It feels fantastic to have a lot more money deposited in my bank account every paycheck. But then it really hurts having to write $20,000-$30,000 checks to Uncle Sam four times a year on January, April, June, and September. I know. Ouch. This year, taxes are due in a few days on January 16, 2018.
To lessen the sting, you can easily make a small profit by paying taxes online using a credit card.
The IRS makes it ridiculously easy to pay your taxes. This isn’t surprising at all. After all, they want their money! There are three primarily options for making payments: 1) online; 2) by phone; and 3) by check or money order using the Estimated Tax Payment Voucher.
I choose to pay online because it is fast and easy. And if you play your cards right, you can easily make a small profit tax free.
How do you profit? Here’s an example. To make things simple, let’s say your estimated quarterly tax payments are $20,000 (a number that is not unreasonable among high income earners such as physicians). When you make a payment using your credit card, there is a convenience fee that is charged by the payment service provider. Select the provider with the lowest fee. (Minimizing fees is always a good idea in the world of finance and investing.) The provider with the lowest fee is www.pay1040.com with a service fee of 1.87%.
Here’s how much you would pay for the convenience of making payments with a credit card.
$20,000 x 1.87% = $20,374
I know what you’re thinking. How can you make a profit paying $374 in fees? Well my friend, the key is to use a credit card that returns at least 2% in rewards or cash back! There are plenty of great credit cards available that offer this. While some cards may offer a better return in travel rewards in specific merchant categories, my favorite credit card to use for every day non-bonus spend is the Citi Double Cash card (not an affiliate link). With this card, you essentially earn 2% cash back by earning 1% on initial purchases then an additional 1% as you pay for those purchases when you pay your credit card bill. The rewards here are valuable because cash is king and fungible. Money in the form of cash can be exchanged for any good or service, whereas travel rewards can only be redeemed for (you guessed it!) travel.
Back to the math. Here’s how much you would earn by using a 2% cash back card for your $20,000 payment.
$20,374 x 2% = $407.48
To calculate your profit, you subtract your expense in fees from your earnings.
$407.48 – $374 = $33.48
Congratulations! You have earned a profit of $33.48!
All things considered
I know it doesn’t sound like a lot. But consider this. Money and rewards that you earn through credit card spending is tax free. The IRS considers credit card rewards a discount, and not taxable income. Therefore you can think of the $33.48 that you earned as equivalent to about ~$50 of earned income (assuming an effective tax rate of about 33%).
If you really want to get down to the nitty gritty details, consider the other options and the opportunity costs associated with each option.
Submitting a payment by mail adds an additional monetary cost in the form of a postage stamp and envelope. This is not much. About 50 cents. You also have to factor in the opportunity cost of time spent going to the mailbox or post office for delivery. Time is valuable.
Paying by phone is another option. It’s basically the same as paying online (with the credit card fees and all) except you have to go through a lengthy automated telephone response system that will guide you through the payment process. Ain’t nobody got time for that.
Let’s ignore the opportunity costs for now and assume that every quarter you can potentially earn $33.48 tax free by using a rewarding credit card to pay online.
Annually, this amounts to $33.48 x 4 = $133.92.
The magic of compound interest
Now let’s say you work for 20 years. And every year you earn $133.92, which you then invest in a total stock market index fund.
Assuming an average annual return of 7%, the same $133.92 invested annually will eventually grow to $6,392.65!
As you can see, it can amount to a big deal over time. To me, it’s a no brainer. There is minimal effort involved.
Short guide to paying taxes online
As I mentioned earlier, making tax payments online is ridiculously easy.
First, go to the IRS website at www.irs.gov/payments. The page should look like this below. Click on the “Debit or Credit” option.
The next page will display the different Payment Processing services. Select Pay1040.com because their service fee is the lowest at 1.87%.
Then select the appropriate tax form. For me, it is Form 1040-ES Estimated tax
After this page, it is very self-explanatory. You enter the tax year, your private information (social security number, address, etc.) and payment information. Look over the information to make sure it’s correct, then press submit.
- Don’t go over your credit limit! For high income earners, tax payments can be quite high. Make sure the available credit limit on your credit card is higher than your tax payment. If you go over the credit limit, you can be charged a fee, the interest rate may go up, and your credit score will go down. Don’t let it happen.
- Split the payments. Keep in mind that you can make up to 2 payments per period, depending on your tax form. See this IRS frequency limit table for details. For instance, if your credit limit is $15,000 on your high rewards credit card and your have a tax payment of $20,000, split it into two separate payments. Submit a payment of $10,000 first. Then, immediately pay off the entire balance once the charge has been posted. This gives you the full $15,000 credit available to you for submitting the other payment of $10,000. I also recommend paying off the credit card balance from the second charge as quickly as possible once posted.
- Beware of other recurring automatic bill payments. Having other recurring charges on the same credit card can put you at risk of unintentionally going over your credit limit. As always, be mindful of automatic payments and of all spending in general.
- Have enough money in your checking account to pay your balance in full. This one is obvious and needs no further explanation.
- Using a credit card to make tax payments is one way to create manufactured spending or to meet spending thresholds for high rewards credit cards sign up bonuses. You have to do the math and determine if the bonus or rewards earned are worth the service fee. Always be responsible with your credit card spending.
- If you have a lot of credit card debt, can’t remember to pay credit card bills on time, or you don’t have a high rewards (at least 2% cash back) credit card, this is definitely not for you. It’s not worth it. Write a check to the IRS and call it a day :).