Is it a good idea to set your deductions high and use the extra money you will get in your paycheck to pay off credit cards?

by David A. Caplan, CPA | May 31, 2018
askacpaicon

A friend of mine has her deductions set at nine, so very little tax is taken out of her check. She uses the cash to pay off her high-interest rate credit cards. At the end of the year she may owe $6,000, but at an interest rate much lower than her credit cards. Does this seem like a smart strategy?

The scheme (and I use that word purposely) sounds extremely risky. It is not something that I would ever recommend. 

First, claiming nine exemptions can sometimes raise a red flag with the IRS. Second, you say that at the end of the year she may owe $6,000, but at a lower interest rate than her credit cards. How does she plan to pay the $6,000? Set up a payment plan with the IRS? Just to set that up costs $105, and the balance due incurs interest and penalty until paid at roughly 13 percent per year. Also, if you miss a payment, the IRS will immediately clamp down on you. You never want to owe the IRS if you can help it. If she can pay off the entire tax amount at the end of the year, why doesn’t she just use that money to pay off her credit cards?

You also say that she uses the extra cash to pay off her credit cards, but that takes a lot of discipline. What happens if she has an unexpected expense one month, and she uses that money for the expense? Then she will owe the credit card companies and the IRS. It would be much better if she could get a loan from a bank or credit union and pay off the credit cards. There are also ways to pay down credit card debt slowly but surely by eliminating the balance on one card at a time. The key there is to stop using the credit cards and live within your means. What she is doing is the worst possible strategy in my opinion.

For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.

Answered by: David A. Caplan, CPA, is a sole practitioner in Lafayette Hill, Pa.

Disclaimer
The responses are based on the limited information provided by the questioner and apply the laws and regulations at the time of posting. Other options could arise as rules and regulations may change over time, including but not limited to the passage of the Tax Cuts and Jobs Act of 2017. They are intended to provide general information, not specific accounting or tax advice; they are not intended or written to be used and cannot be used for the purpose of avoiding or evading taxes or penalties under the IRS code or regulations. Views expressed do not imply an opinion of the PICPA, its officers, directors, employees, or members.
Financial FAQs

Search the most frequently asked finance and accounting questions and read the responses from PICPA members. Always consult a CPA before taking action.

Search