Does tax debt lower your credit score? Here is the summary

A good credit score can make your life easier, so it's best to make sure your decisions have a positive rather than negative impact on your score. When it comes to your tax debt and how it can affect your credit score, it may not be clear if this type of debt affects your score, so you may have questions.

You must first make sure you understand how credit scores work if you want to fully understand what effect, if any, your tax debt may have on your credit score.

How are credit scores calculated?

When you apply for a home loan, credit card, or even car insurance, your approval may depend on your credit score. Creditors like to see that you are financially responsible, and your credit score gives them insight and answers questions about your ability to successfully manage your debts. Many things are taken into consideration when calculating your credit score, and depending on the information provided, your score could fall anywhere on the scale.

What effect does tax debt have on a person's credit?

Many Americans will have tax debt that they are responsible for at some point in their lives. And some may not have paid off that debt yet. Since your credit score takes into account the total amount of your debt, you can assume that your tax debt is included in this amount. Although tax debt is a debt, it is not actually factored into the debts used to calculate your credit score.

In the past, when you owed a tax debt and failed or refused to pay it, the IRS would file what is called a Notice of Federal Tax Lien. Basically, this notice stated that the IRS had claimed ownership of your property until the tax debt was paid or another resolution was reached. Because this notice would tell creditors that you had not paid your federal tax debt, when creditors saw the federal tax lien notice, it would be difficult to get approved for credit. This was likely because there would be concerns about the consumer's ability to repay their debts.

All that changed in 2017 when the three credit bureaus, Transunion, Equifax and Experian, decided to no longer list federal tax liens or judgments on credit reports. From that point on, tax liens no longer have an effect on consumer credit scores. Previous tax liens were also removed from credit reports if they were still listed. Consumers should note that even though federal tax liens no longer impact your credit, a notice of federal tax lien may still be filed.

Like any debt you owe, you cannot ignore tax debt because your unpaid tax debt can have other negative consequences on your life. If you have a tax debt, rather than ignoring it, you will want to pay it. The ideal would be for taxpayers make their payments by the due date, but those who cannot pay in full have options that will allow you to settle your debt over a predetermined period of time and avoid a tax lien or other consequences of unpaid taxes.