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Is Credit Card Interest Tax Deductible?

Dan Caplinger, The Motley Fool

Find out if you can get a valuable tax write-off when you carry a balance on your card.

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Everyone likes to get a break on their income taxes. Because some of the most popular tax deductions involve paying interest on debt, such as mortgages and student loans, credit card users often ask whether the interest charges they incur when they carry a balance on their cards is tax-deductible.

Unfortunately, most people aren't allowed to deduct their credit card interest on their tax returns. However, there are a few cases in which a deduction might be allowed.  If you qualify, then it can be worth your while to track your credit card interest and work with your accountant to claim it appropriately when you file your taxes.

The big reason why most credit card interest isn't tax-deductible

Most of the time, credit card interest isn't eligible for a tax deduction. The reason is simple: The tax laws don't usually grant a deduction for debt that's incurred for personal reasons. Because most people use their credit cards for their personal use, any interest charges they incur therefore typically don't qualify for a tax deduction.

It's true that mortgage interest and student loans are both types of personal debt. Most people borrow to purchase their primary residences and use those homes exclusively for personal purposes rather than for a business, and schooling is inherently personal. But that's what makes those deductions two of the biggest exceptions to the general rule, offering tax breaks that are worth hundreds of billions of dollars in total for American taxpayers.

Nearly every other type of personal debt you can think of gets no such favorable treatment. Auto loans, payday loans, and bank personal loans aren't tax-deductible, and even home equity lines of credit have seen their rules change recently. As a result, you generally won't be able to deduct any interest you pay on your credit cards.

Business credit card charges and deductible interest

However, the issue of credit card deductibility isn't quite as easy to address as with a simple “no.” There are situations in which you can deduct credit card interest: if the spending relates to a legitimate business expense.

The most common example of how this plays out in real life is for entrepreneurs. If you're self-employed, then you'll typically have plenty of expenses to pay on behalf of your business. Those who pay for those expenses using a credit card and then subsequently have to pay finance charges on their outstanding card balances have incurred a business interest expense, and that's typically deductible against income from the business.

The same is true for small businesses that are set up as partnerships or limited liability companies. The difference there, though, is that the business entity itself might be required to file a return, and if that's the case, coordinating the reduction in business income that gets passed through to you as a partner or LLC member and the numbers that you'll report on your individual tax return is crucial in order to avoid raising red flags.

However, it's important to understand that just because you have a business doesn't mean that you have a free hand to deduct any credit card interest at all. The only expenses eligible for an interest deduction are those that are related to your trade or business activity. That's why it's usually best to get a business credit card so that you can separate out clearly and distinctly your personal expenditures from your business purchases.

Don't make a costly mistake

The fact that credit card interest isn't usually tax-deductible is just one more reason why carrying a balance on your credit cards doesn't make sense in the first place. Getting charged extremely high interest rates and not being able to deduct that interest on your tax return shows just how costly having an outstanding credit card balance can be -- and why avoiding that costly mistake by paying your balance in full every month is the best way to handle your finances.

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