For business owners, knowing which expenses qualify for tax deductions is pivotal in optimizing tax returns. A common query often revolves around the deductibility of interest paid on business credit cards. The short answer is yes, but there are important details to consider.
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The Fundamentals of Deducting Business Credit Card Interest
The Internal Revenue Service (IRS) permits the deduction of interest accrued on business-related expenses as an eligible business expense. Essentially, if your credit card is utilized for business purchases, the interest accumulated on those transactions can lower your taxable income.
2023 Tax Updates: What You Need to Know
Stay informed about the latest tax changes for 2023:
- Maximum Net Earnings: The maximum net self-employment earnings subject to the social security portion of the self-employment tax is $160,200 for 2023. There’s no maximum limit on earnings subject to the Medicare portion.
- Standard Mileage Rate: In 2023, the standard mileage rate for business use of your car, van, pickup, or panel truck increased to 65.5 cents per mile. Refer to “Car and Truck Expenses” in chapter 8 for more details.
- Redesigned Form 1040-SS: For 2023, Schedule(s) C and SE (Form 1040) can be filed with Form 1040-SS if applicable. Find additional information in the Instructions for Form 1040-SS.
- Bonus Depreciation: The bonus depreciation deduction under section 168(k) starts phasing out in 2023, reducing the applicable limit from 100% to 80%.
- Form 7205, Energy-Efficient Commercial Buildings Deduction: This form and its instructions are utilized to claim the section 179D deduction for qualifying energy-efficient commercial building expenses. These expenses are now reported on line 27b of Schedule C (Form 1040). Check Form 7205 and its instructions for further details.
- Commercial Clean Vehicle Credit: Businesses purchasing qualified commercial clean vehicles may be eligible for a clean vehicle tax credit. Refer to Form 8936 and its instructions for eligibility criteria.
- Business Meal Expense: The temporary 100% deduction for business meal expenses expired. Beginning January 1, 2023, the business meal deduction reverts back to the previous 50% allowable deduction. See “Meals and Lodging” section for more details.
2024 Tax Updates: What to Expect
Stay ahead with the latest tax changes for 2024:
- Maximum Net Earnings: The maximum net self-employment earnings subject to the social security portion of the self-employment tax is $168,600 for 2024.
- Standard Mileage Rate: In 2024, the standard mileage rate for business use of your car, van, pickup, or panel truck is 67 cents per mile.
For additional changes and updates, visit IRS.gov. Stay informed to ensure compliance and optimize your tax strategy.[1]
Non-Deductible Business Expenses:
Certain expenses cannot be claimed as business deductions. These include:
- Bribes and kickbacks.
- Charitable contributions.
- Demolition expenses or losses.
- Dues to business, social, athletic, luncheon, sporting, airline, and hotel clubs.
- Entertainment expenses.
- Improvements to real or tangible personal property, such as betterments, restorations, or adaptations to a new or different use.
- Lobbying expenses.
- Penalties and fines paid to governmental agencies for breaking the law.
- Personal, living, and family expenses.
- Political contributions.
Settlements or payments related to sexual harassment or abuse, particularly those under nondisclosure agreements. Attorney fees associated with such settlements or payments are also non-deductible.
Criteria for Claiming Credit Card Interest Deduction
To be eligible for this deduction, specific criteria must be met:
- Interest From Business Expense Origin: The interest must be tied to business expenses, defined by the IRS as those deemed “ordinary and necessary” for conducting business operations.
- Operating Costs: This includes expenses such as rent for business premises, utilities, insurance premiums, and office supplies.
- Employee-related Expenses: Wages, salaries, benefits, and other compensation paid to employees.
- Equipment and Supplies: Costs incurred in purchasing and maintaining equipment, machinery, and supplies necessary for business operations.
- Marketing and Advertising: Expenditures on advertising campaigns, marketing strategies, and promotional activities aimed at expanding the business’s reach and attracting customers.
- Travel and Entertainment: Business-related travel expenses, including transportation, accommodation, and meals, as well as expenses for client meetings, conferences, and networking events.
- Professional Services: Fees paid to accountants, lawyers, consultants, and other professional service providers hired to support the business’s operations and growth.
- Interest on Business Loans: Interest accrued on loans and credit lines used to finance business activities, purchase assets, or cover cash flow gaps.
- Maintenance and Repairs: Costs associated with maintaining and repairing business property, equipment, and vehicles to ensure smooth operations.
Carry forward of Disallowed Business Interest Expense:
Under Section 163(j), disallowed business interest expenses can be carried forward indefinitely.
Temporary Modification by the CARES Act:
The Section 163(j) rules, initially established by P.L. 115-97, underwent temporary modification due to the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) (P.L. 116-136). Specifically, for tax years commencing in 2019 and 2020, the CARES Act increased the percentage of a taxpayer’s adjusted taxable income (ATI) from 30% to 50% for calculating the limitation under Section 163(j).
Elective Options for Taxpayers:
Taxpayers, excluding partnerships (details on partnerships below), had the option for tax years 2019 or 2020 to elect not to increase their ATI percentage from 30% to 50%. Once such an election was made, it could only be revoked with the IRS’s consent.
Partnership Specifics:
In the case of partnerships, the change in ATI percentage did not affect the 2019 tax year. Instead, 50% of any excess business interest expense (EBIE) allocated by the partnership to each partner in 2019 was deemed paid or accrued by the partner in 2020 and not subject to Section 163(j). The remaining 50% of each partner’s 2019 EBIE remained subject to the standard rules of Section 163(j). Partners had the option to elect out of this special rule for 2019. For 2020, the change in ATI percentage applies to partnerships unless the partnership (not the partners) elects out of the rule.
Substitution of ATI for Calculations:
Additionally, for tax years commencing in 2020, taxpayers (including partnerships) could generally elect to substitute their 2019 ATI for their 2020 ATI in performing the calculation. Special rules apply to this election for short tax years.
Debt Liability: You can only deduct interest if the credit card used is in your name or in the name of your business.
Bad Debts:
When you’re unable to collect money owed to you, it constitutes a bad debt. There are two categories of bad debts—business bad debts and non-business bad debts.
A business bad debt typically arises from the operation of your trade or business. You may qualify to deduct business bad debts as an expense on your business tax return.
Definition of Business Bad Debt:
A business bad debt refers to a loss incurred due to the worthlessness of a debt that falls into one of the following categories:
- Created or acquired in the course of your business.
- Closely related to your business at the time it became partially or completely worthless.
It’s important to note that a debt is considered closely related to your business if the primary motive for incurring the debt is business-related.
Origins of Business Bad Debts:
Business bad debts often stem from credit sales to customers. They can also arise from loans extended to suppliers, clients, employees, or distributors. These unpaid debts are typically recorded in your books as either accounts receivable or notes receivable. If you’re unable to collect any portion of these receivables, the uncollectible amount is recognized as a business bad debt.
It’s important to note that you cannot deduct credit card interest incurred from business expenses if the purchase was made on someone else’s credit card.
Previously, credit card interest on personal expenses was deductible. However, the Tax Reform Act of 1986 brought about changes, eliminating the deduction for interest accrued on personal expenses. According to IRS regulations, if you’ve used your credit card for both personal and business purchases, you are only eligible to deduct the interest accrued from business expenses.
Fortunately, many business credit cards provide itemized statements and year-end reports, facilitating the process of determining the amount of interest billed, thereby aiding in accurate deduction calculations.
Accounting Methods and Interest Deduction
Accounting Methods:
An accounting method comprises a set of principles used to determine the timing and manner in which income and expenses are recognized. It encompasses not only the overarching approach to accounting but also the treatment of significant items within it.
Selection of Accounting Method:
When you file your initial income tax return that includes a Schedule C for your business, you make the choice of accounting method. Any subsequent changes to your accounting method generally require approval from the IRS. Refer to “Change in Accounting Method” for further details.
Types of Accounting Methods:
You have several options for accounting methods, including:
- Cash method
- Accrual method
- Special methods tailored for specific items of income and expenses
- Combination method incorporating elements of two or more of the above
Consistency in Accounting Method:
Consistency is paramount in accounting. You must use the same accounting method both for determining your taxable income and for maintaining your financial records. Additionally, your chosen method should clearly depict your income.
Treatment of Business and Personal Items:
You can employ different accounting methods for business and personal items. For instance, you can calculate your business income using an accrual method while using the cash method for personal transactions.
Management of Multiple Businesses:
If you operate multiple separate and distinct businesses, you can use a different accounting method for each provided that the method accurately reflects the income of each business. To be deemed separate and distinct, each business must maintain comprehensive and separate books and records.
The method of accounting you employ determines how interest is reported:
Cash Accounting Method:
Under this method, you can deduct only the interest you’ve physically paid within the tax year.
- The cash method is favoured by most individuals and many sole proprietors who don’t deal with inventory due to its simplicity in record-keeping.
- However, if your business requires inventory management for income calculation, the accrual method is typically necessary for sales and purchases, unless you qualify as a small business taxpayer.
Cash method include: Income, Constructive receipt, delaying receipt of income, Checks, Debts paid by another person or cancelled, Repayment of income and Expenses.
Income :
Example:
On December 30, 2022, a client sent you a check for interior decorating services provided to them. Although you physically received the check on January 4, 2023, you must include the amount of the check in your income for the tax year 2023.
Constructive receipt:
Example:
Interest is credited to your bank account in December 2023.Even if you don’t withdraw or enter it into your passbook until 2024, you must include it in your gross income for the tax year 2023.
Delaying receipt of income:
Example:
A service contractor was entitled to receive a $10,000 payment on a contract in December 2023. Although informed in December that the payment was available, they delayed receiving it until January 2024 at their request.
Despite not physically receiving the payment until 2024, they must include it in their income for the tax year 2023 because it was constructively received in 2023.
Checks:
Example:
You received a check for $500 on December 30, 2023, from a client. Despite being unable to deposit the check into your business account until January 3, 2024, you must include this fee in your income for the tax year 2023.
Debts paid by another person or cancelled:
If your debts are paid by someone else or cancelled by your creditors, you might need to report part or all of the debt relief as income. Constructive receipt of this income occurs when the debt is cancelled or paid.
Repayment of income:
If you include an amount in income and later have to repay all or part of it, you can usually deduct the repayment in the year you make it. However, if the repayment amount exceeds $3,000, a special rule applies. For further information, refer to the “Repayments” section in chapter 8 of Pub. 17.
Expenses under the Cash Method:
Generally, expenses are deducted in the tax year they are paid under the cash method. This includes business expenses, even those for which you dispute liability. However, you may not be able to deduct expenses paid in advance or may need to capitalize certain costs, explained later under Uniform Capitalization Rules.
An expense paid in advance can be deducted only in the year to which it applies.
For example, if you pay $1,000 in 2023 for a business insurance policy effective for one year beginning July 1, you can deduct $500 in 2023 and $500 in 2024.
Accrual Accounting method:
This approach allows you to deduct interest in the year it was billed, regardless of when it’s actually paid, provided certain conditions are met.
When using the accrual method of accounting, you typically record income in the year it is earned and expenses in the year they are incurred. The aim of this method is to align income and expenses accurately in the respective years.
Income:
Under an accrual method of accounting, income is generally included in your gross income for the tax year in which all events that determine your right to receive the income have occurred and the amount can be reasonably determined.
Example: A calendar year accrual method taxpayer sells a computer in December 2023, bills the customer in January 2024, and receives payment in February 2024. The income from the computer sale must be included in the taxpayer’s 2023 income.
Special Rules for Income:
Estimated Income: If you include a reasonably estimated amount in gross income and later determine the exact amount is different, adjust it in the year you make the determination.
Change in Payment Schedule for Services: Accrue income at the basic rate specified in the contract, even if payments are received at a lower rate until services are completed.
Advance Payments: Generally, report advance payments as income in the year received. However, you can elect to postpone including advance payments in income until the next tax year.
Expenses:
Under an accrual method, deduct or capitalize a business expense when the all-events test has been met and economic performance has occurred.
Example: A calendar year taxpayer using the accrual method buys office supplies in December 2023, receives them and the bill that month, but pays the bill in January 2024. The expense can be deducted in 2023 because all events that fix the liability have occurred, the amount could be reasonably determined, and economic performance occurred in that year.
Special Rules for Expenses:
Keeping Inventories: Generally, if the production, purchase, or sale of merchandise is income-producing, inventory accounting is required. Use an accrual method for purchases and sales unless you’re a small business taxpayer.
Related Persons: Business expenses and interest owed to a related person using the cash method cannot be deducted until payment is made and included in the related person’s gross income.
Distinguishing Between Personal and Business Expenses
It’s imperative to differentiate between personal and business expenditures. Interest incurred on personal expenses is not deductible. If your credit card serves both personal and business purposes, only interest related to business expenses is eligible for deduction.
| Personal Expenses | Business Expenses |
| Groceries | Office Supplies |
| Clothing | Advertising |
| Rent/Mortgage | Travel Expenses |
| Utilities | Equipment Maintenance |
| Entertainment | Professional Fees |
| Dining Out | Rent for Business Premises |
| Personal Travel | Business Insurance |
| Gifts | Business Meals |
| Gym Memberships | Internet and Phone Services |
| Personal Insurance | Business Vehicle Expenses |
Strategies for Deducting Business Credit Card Interest
Here are some practical tips to optimize your deduction:
Maintain Detailed Records: Many business credit card providers furnish itemized statements and annual reports, simplifying the tracking of interest charges.
Utilize a Business Credit Card: Although not obligatory, using a business credit card streamlines record-keeping and ensures that interest is distinctly associated with business expenditures.
Compare Business Credit cards:
| Card Name | American Express Blue Business Cash™ Card | Capital One Spark Cash Plus | Chase Ink Business Cash Credit Card |
| Annual Fee | $0 | $150 | $0 |
| Regular APR | 18.49%-26.49% Variable APR | N/A | 18.49%-24.49% Variable APR |
| Intro APR on Purchases | 0% intro APR on purchases for 12 months | N/A | 0% intro APR on Purchases for 12 months |
| Recommended Credit Score | 690-850 | 720-850 | 690-850 |
Bottom line:
Leveraging the deduction of business credit card interest can significantly contribute to tax savings. However, meticulous record-keeping and a comprehensive understanding of tax regulations are imperative. When uncertain, seeking advice from a tax professional ensures you capitalize on deductions while adhering to IRS guidelines.
