This is a guest post from Adam Jusko, founder of IndexCreditCards.com, a credit card information site where you can compare credit card offers. Please consider following Adam on Twitter for quick credit tips and opinions.
American Express recently announced that it was teaming up with two independent payment agencies to allow its cardholders to pay their federal, state or local taxes with Amex Membership Rewards points. On the surface, this sounds like a good use of points that might otherwise sit in your account for months or years before you get around to redeeming them. However, there is a potential downside to consider if you’re thinking of using this service.
I’ll explain the process in greater detail, but here’s the crux of the issue: If you pay your taxes with Membership Rewards points, you won’t only be paying your taxes, you’ll also be paying an extra 2.35% fee to cover what are essentially credit card processing costs. In other words, if you owe $1, 000, you can pay with points, but you will be paying a bill that in actuality is now $1023.50.
To further complicate matters, you should understand that the redemption rate for Membership Rewards points on tax payments is 200 points per dollar — in general, the industry standard for points redemption is 100 points per dollar. For example…
You can redeem 2, 500 Membership Rewards points for a $25 Home Depot gift card, but that same 2, 500 points would only offset $12.50 in taxes. So you’re getting half the value from those points if you use them for tax payments compared to their value when used for other rewards.
If you don’t understand why your tax bill goes up by 2.35% when you pay with points, a quick primer on the system American Express is using to offer the points-for-taxes deal will make it more clear. For a number of years, the Internal Revenue Service has allowed you to pay your taxes via credit card. However, by law, the IRS can not pay the processing fees that banks would charge if the government accepted your credit card directly.
Instead, the IRS outsources the credit card collection to authorized partner companies who can accept your credit card payment — for an additional fee to cover the credit card processing fees. In order to get the convenience of paying by credit card, you agree to pay a fee that is a percentage of the taxes you owe (see also You Can Pay Taxes By Credit Card; Here’s Why You Shouldn’t).
What American Express has done is to team up with two of these authorized government partners — Pay1040.com and OfficialPayments.com — in order to make Membership Rewards points one of the payment options when you use these services. In essence, you are paying your taxes by credit card — with the additional 2.35% fee — but you can offset or completely cover your taxes due with the points in your Membership Rewards account.
Deal or no deal?
You may see the reduced value of your points as a perfectly fine trade-off for the opportunity to use points instead of “real” money for tax payments. Or, you may choose to pay in a traditional way and get full value for your Membership Rewards points via gift cards or other rewards. Whatever you choose, it is worth knowing the pros and cons beforehand so you can make a sound decision.
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