Credit card Q&A: “Are credit card payments tax deductible?”
Sure, credit cards provide convenience, payment protection, a bevy of rewards, and so on.
But they can also land consumers in debt because plastic tends to carry some of the highest interest rates around.
If you happen to be one of the many who paid a ton of interest on your credit card in the past year, you might be thinking it could be a nifty little write-off, a simple way to cut your tax bill.
Well, before you get too excited, note that it’s unlikely that you’ll be able to write off the interest portion of your credit card payments.
Tax Reform Act of 1986 Eliminated Personal Interest Deduction
In late 1986, Congress passed the Tax Reform Act of 1986, which was essentially enacted to close loopholes, consolidate tax brackets, and reduce the number of possible deductions.
This simplification of the tax code led to the elimination of the personal interest deduction, which meant individuals could no longer write off credit card interest, among other things.
While this probably came as a blow to many consumers, savvy folks quickly circumvented the rule with the use of home equity loans and lines of credit.
These are still tax deductible today, assuming certain guidelines are met, making them popular as debt consolidation loans.
Essentially, homeowners can use these loans or lines of credit to pay off high-APR credit card debt, similar to how credit card balance transfers work.
When homeowners pay interest on the equity loans/lines, the interest portion is deductible each year on Schedule A (where you itemize deductions).
The limits of this deduction vary – if the home equity loan/line wasn’t used to improve your home, you’re generally limited to deductions on the first $100,000 in home equity debt.
Additionally, if your home equity loan/line exceeds the fair market value of your home, that portion is considered personal interest and is not deductible.
The limits are much higher if the home equity debt was used to improve, build, or buy your home.
*Speak with a CPA or tax adviser for all the important details and guidelines.
Two Benefits to Using Home Equity
As noted above, you may gain the ability to deduct credit card interest when it’s paid off using a home equity loan or line.
While this could be advantageous, it’s only one of the benefits. The other big plus is that the interest rate will likely be much lower.
The average interest rate on a credit card is around 15%, while many home equity loans have rates in the low single-digits.
So not only would you gain the tax deduction, but you’d also save on interest thanks to a much lower associated interest rate.
Of course, the drawback is that you’re taking on another loan tied to your property, which could lead to other problems down the line.
There are also costs associated with opening a line of credit or home equity loan. In other words, do the math to see if it actually makes sense.
Not everyone itemizes deductions, and even if they do, the savings from deducting credit card interest might be negligible, at best.
Do You Use Your Credit Card for Business?
If you use your credit card for business purposes, the interest portion of payments can be tax deductible.
This is the case whether we’re talking about a sole proprietorship or a corporation. If you charge up business expenses on your credit card and pay interest, it becomes a business expense.
Makes sense, doesn’t it? For that reason, it becomes a tax-deductible event, which is a plus for business owners who rely on credit cards to fund their operations.
Just be careful not to mix up your personal credit card bills and your business credit card bills. If you have to go through and separate the two, it’ll be a big headache.
Note: As always, consult a CPA and/or tax adviser when dealing with any tax-related issues, as they are the only individuals qualified to handle such questions.
A Better Alternative
You might not need to play around with home equity lines/loans at all. A simple alternative could be a balance transfer credit card, or a simple call to your credit card issuer to lower your interest rate.
Sure, you may still be subject to a balance transfer fee, but this is a quick and easy way to avoid paying interest. And the savings may exceed what you could save by writing off the interest as a tax deduction, all with less legwork.
In general, if you carry a credit card balance, you should have 0% APR. There’s no reason to subject yourself to a high rate of interest with the many low-rate options available today.