Will a Tax Audit Affect My Credit?

After weeks or even months of preparation, filing your taxes is a welcome relief. Unless, of course, you are facing an audit. According to data collected by the IRS, many of us don’t have to worry. Audits were at an all-time low in 2014. Roughly 1.2 million taxpayers were affected last year, a 12 percent drop since 2013. Despite the decline, it’s important to understand the basics. Read on to learn how an audit could affect your credit and finances.

What is an audit?

An individual tax audit is a review performed by the IRS to verify that your deductions, income and other tax information are accurate and reported correctly.

What should I do if I’m audited?

The IRS will contact you with instructions during an audit. In the meantime, gather relevant information to streamline the process, including:

• A copy of your latest return
• Pay stubs and other proof of income
• Receipts and other documents to support your deductions
• Copies of your latest bank statements

Contact your accountant or original tax preparer to review the math and help you identify any issues.

Will an audit appear on my credit report?

Your credit information is housed and reported by the Big Three: TransUnion, Experian and Equifax. Although the IRS is responsible for reviewing your financial information every year, they are not responsible for providing credit to consumers and will not report an audit to the bureaus.

Can the effects of an audit damage my credit?

Although the IRS will not report an audit to the credit bureaus, the results are another story. If the agency finds that you owe federal back taxes, penalties and other fees, they will work with you to establish a payment plan to recoup the debt. Failure to pay will result in a tax lien, a derogatory mark that will remain on your credit report for up to 7 years for paid accounts and up to 15 years for unpaid accounts. (Note: Even if you choose to pay, back taxes totaling $10,000 or more require the IRS to file an automatic Notice of Federal Tax Lien in your credit file.)

The sum of these consequences equals one thing: credit damage. Although FICO has taken steps to improve their scoring model, it won’t protect your credit completely. Damage ranges from several points to several hundred depending on the severity of the citation and your efforts to repay the debt.

How will an audit affect my finances?

A damaged credit score spells trouble for your finances. In addition to dealing with outstanding debt, you’ll struggle with:

• Securing new credit. To lenders, a low credit score equals high risk. A tax lien won’t help you in future transactions. Buying a home, car and even financing an education could prove difficult.
• Higher interest rates. As your risk level increases, so will your interest rates. You may see a shift in credit card APR and insurance premium amounts after a tax lien appears on your credit reports.
• Saving money. An increase in interest means lost savings, a consequence that is sure to affect your bank account. Failure to save will impact your ability to handle emergencies, plan for retirement and make the most of your income.

The bottom line: An audit from Uncle Sam may be stressful, but there are ways to avoid long-term damage. Work with your accountant and the IRS to resolve the issue as soon as possible. The result will protect your credit and your bank account.