Small businesses that operate as sole proprietorships can use credit cards next year to pay their IRS bills if they file electronically. But the new payment option gets a poor rating from small-business accountants: It's no bargain, and the temptation to let tax payments build on credit-card bills is great.

The IRS announced in August that those who file 1040 personal income tax forms electronically in 1999 can pay their taxes with American Express, Discover, and MasterCard. Visa didn't participate. The credit-card option is a one-year pilot. Sole proprietors are eligible because they file business tax returns as an attachment, Schedule C, to the 1040 form. Other small businesses -- C corporations, S corporations, and limited partnerships -- won't be able to use credit cards (although the IRS says it may let them do so in the future).

A TRICKY TRACK. Tax experts warn that this option is no freebie. First, the two companies that handle these transactions for the IRS will charge convenience fees -- and only one has disclosed its levy, which will be 2% to 3% of the bill. John N. Evans, deputy director of enterprise practice for Arthur Andersen & Co. in New York says that's reason enough to avoid the credit-card route -- especially if you have your tax money salted away. Even if you are in danger of coming up short at tax time, Evans counsels, "Look at other financial alternatives," including an installment plan with the IRS or borrowing from a friend or relative.

Don't be fooled into seeing credit cards as a cheap or backdoor way to get extra time to pay. Entrepreneurs who use their cards to pay taxes will not be able to deduct interest payments for outstanding balances after their 30-day grace period -- even if they use the company credit card. That's because the money is accruing for income tax expenses. "I advise people not to use credit cards for taxes because interest expense is not deductible," says Joseph Unger, tax partner at M.R. Weiser & Co. in New York. Unger says things can get really tricky if the credit card has a preexisting balance for deductible business expenses. It is very complicated to parse what is deductible from what is not in a revolving balance, he says.

If you still think credit-card payments look attractive -- maybe you have a bargain rate -- consider this, says Ed Slott, a New York area accountant and small-business specialist: The risks of using plastic to pay taxes are as much psychological as financial. The IRS's aggressive debt collection is strong motivation to pay taxes down rapidly, whereas a credit-card company will happily let the debt accumulate indefinitely. "It's a matter of discipline. That's what no one takes into account," says Slott. With tax bills mounting to often thousands of dollars, it's easy to see that what looks like a convenience could quickly become a nightmare.

By Jeremy Quittner in New York
jeremy_quittner@businessweek.com

To: FINANCE