Interest on a credit card used for personal expenses falls in the category of ‘personal interest’ and therefore, it is not qualified for tax deduction. However credit spending on business expenses is eligible for tax deduction. Tax deduction on credit card interest for personal expenses was valid prior to 1986. It was rolled back in the Tax Reform Act of 1986 to stimulate savings and tax collection because prior to the reform, people were motivated to increase spendings to reduce their tax liability.
However, after the act came into effect, interest on any loan (not just credit card debt) borrowed for expenses related to personal consumption became ineligible for tax deduction. Whether lower consumer spending and higher taxes is better than higher consumer spending and lower taxes is debatable and beyond the scope of this topic.
Tax Deduction on Credit Card Interest for Business Expenses
The tax reform allows tax deduction on interest paid on credit debt used for business expenses. Regardless of whether you’re a business owner or a freelancer, whatever credit you spend on business or work related expenses will be eligible for tax deduction.
The IRS does not specify that you need a separate business credit card in order to be eligible for tax deduction so you can use a single card for both personal and business use but will get tax deduction only on the interest paid for business expenses.
However, it is usually beneficial to have separate credit cards for personal and business use to avoid maxing out your card if you were only using one. A single card for both use cases would put you at risk of reaching your credit limit resulting in loss in your credit score. Ideally, your credit spending should not exceed 30% of the credit limit on your credit card if you want to maintain a good credit score.
Permissible Interest Expense
In tax years following 2017, a limit has been placed on the amount of business interest you can get deducted for businesses that have $26 million or more in gross receipts. The IRS set the upper bound for the deduction at:
- The business interest income
- 30% (50% in some cases) of your adjustable taxable income
- Your floor-plan interest expense
Types of Interests Qualified for Tax Deduction
There are several types of loans whose interests qualify for tax deductions. They’re listed below:
- Home loans including mortgages
- Student loans
- Interests paid on investment limited to net investment income
- Credit for business expenses.
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