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Can You Deduct Credit Card Interest?


Credit Card Interest

Understanding tax code is about as easy as coring apples after you’ve made jelly. The IRS allows certain deductions as you’re getting to your true taxable income. It’s a slow, winding and frustrating task; unfortunately, it’s also a legal responsibility that we get it right. Figuring out whether something’s deductible is the challenge.

Perhaps figuring out what type of credit card interest is deductible is the “somebody hit me in the head and don’t wake me up until after tax season” challenge. We went straight to the source in an effort to find out what’s allowed and what’s not allowed when it comes credit card interest. What follows is our five minute crash course.

Credit Card Deduction Back Story

Many think the deductions and associated laws surrounding them have been around forever, but it wasn’t until the 1986 Tax Reform Act went into effect that big provisions were made and defined in our country’s tax code. The biggest change, of course, was the elimination of the personal interest deduction. Before the law went into effect, taxpayers were allowed to deduct all credit card interest payments, regardless of what they purchased.

What is personal interest?

According to the IRS, personal interest is defined as “interest paid for goods and services you don’t use for work or business-related purposes.” A few examples include clothing purchases, electronics like computers, TVs and smartphones; cars and food bought with your credit card. When you make monthly payments that include interest, it is always nondeductible personal interest. This remains true even if you use the credit card to subsidize the purchase of your home.

Personal interest also includes credit card service charges, credit card investigation fees (that aren’t reimbursed or paid for by your credit card company as part of its 0 fraud liability offer), late fees, annual fees and other fees associated with your credit cards.

There’s an exception, though. According to the IRS, if you use your credit card for business purposes, such as buying equipment, office supplies, petty cash and other normal business expenditures, the interest payments made on the balance are deductible as business expenses. Be careful, though. If you use your credit card to make those purchases and your company reimburses you, they’re the ones who get the tax break since the reimbursement removed you from the equation. This also means if you use the credit card for both business and personal purposes, you need to make sure you deduct only the interest that was part of the business related purchase.

Turning Nondeductible to Deductible

There are transitions that allow us to make a once-non qualifying deduction into one that is. The IRS uses this example:

If you take out a student loan to pay for college, you’re given the opportunity to deduct the interest payments for the life of the loan. Don’t lose that advantage, though, by paying your student loans with your credit card – you defeat the purpose as you’ll then be paying credit card interest.

Another example includes taking out a home equity loan. These loan structures can provide cash for purchases you need to make and you’ll be able to deduct the interest on the HELOC.

Government Credit

Purchases such as gasoline made on a non profit or government credit card are generally exempt from tax, that means the credit card company itself is deemed the one who pays the taxes (it doesn’t collect tax from the agencies, so therefore, it pays the tax). It gets the benefit of using that for its own claims. This means it might not be to your advantage to use your own credit card for purchases since in many instances, the government body or non profit is prohibited from including in your reimbursement any taxes. Often in these instances, the agencies has additional credit cards they issue to employees and volunteers. Be sure to check on that if you travel for a non profit or government entity.

IRS Forms

Here are some of the most commonly used forms that are applicable for interest deductions. All can be located by visiting the IRS site at irs.gov. You can also find countless frequently asked questions, articles and links to other resources.

Form 1040 provides information on the types of interest you can deduct as itemized deductions; including investment interest (limited to your net investment income) and qualified residence interest.

Publications 17 and 550 provide information on investment interest .

Topic 456 and Publication 970 provides guidance on student loan interest.

Publication 936 offers guidance on home mortgage interest deductions – there are varying circumstances, including those mortgages taken out prior to 1988, other grandfathered debt, acquisition debt considerations and others.

If you have unique circumstances associated with your mortgage, see Publication 936.

Also, taxpayers may be able to use deductions on their federal tax returns if they were issued mortgage credits from the government – either federal or state – for low income housing. See Form 8396, Mortgage Interest Credit. You can also see Publication 530, Tax Information for Homeowners and if you’re a first time homeowner, be sure to explore Topics 611 and 612. Remember, too that qualified residence interest and points are provided to you by your bank or mortgage company. That form number you should receive is Form 1098, Mortgage Interest Statement.

Ultimately, you’re always encouraged to seek the assistance of a professional tax preparer or accountant, especially if there are small business considerations. Small business owners have an entirely different rule book and it’s easy to confuse our personal expenses with those that are part of running a business. The IRS has many resources on its site, and fortunately, there has been a shift in recent years to provide clearer language and less-intrusive policies. Remember, the laws change on a dime and even if you’re doing your own taxes, it’s up to you to ensure you’re applying current guidelines and laws.

Do you do your own taxes each year or do you pay a company or accountant? Do you think the tax codes have been simplified enough in recent years? Share your thoughts.

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