Credit Card Interest – Tax Deductable?

It would be nice if we all lived in a perfect world. A lot of us spent a certain amount of time believing in the tooth fairy when we were kids. Lose a tooth, place it under the pillow, and a few bucks magically appeared the next day.

Or maybe the myth of Santa Claus applied to you as it did to many others – be good all year, make a wish list, and then Santa and his helpers would come down the chimney and give you all the gifts you wanted that year. Not a bad deal. Sooner or later, however, we all grow up, get disillusioned, and realize, unfortunately, that the tooth fairy and Santa Claus don’t exist. And that leads us to our discussion of whether we can deduct personal credit card interest expense from our personal income taxes.

Unfortunately, for the past thirty-plus years, the prospect of doing so has been about as real as the existence of the tooth fairy or Santa Claus.

Personal Credit Card Interest is not Tax Deductible

The Tax Reform Act of 1986 eliminated the opportunity for individuals to deduct credit card interest expense from personal income tax returns. The reasoning behind the change back then was that credit card spending and associated interest expense discouraged savings – and that this reduction in savings and interest income resulted in lower overall taxable personal income, thereby lowering tax revenues.

Furthermore, to allow individuals to deduct credit card interest payments from taxable income would only reduce tax revenues even further. Therefore, the IRS defined which interest expenses would be classified as personal interest expenses that would no longer be considered tax deductible on a personal tax return. These personal interest expenses include those associated with credit cards, back-taxes at the federal, state and local level, and any interest expenses associated with auto loans and unpaid utility bills.

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Credit Card Interest - Tax Deductable

Is Any Interest Expense Tax Deductible?

There is a silver lining. Some interest expense is tax deductible. Interest expense associated with student loans, as well as with loans borrowed to purchase investment property, is tax deductible. Furthermore, interest expense associated with home loans – including mortgages and home equity loans – is also tax deductible. Finally, interest as a business expense is tax deductible – and here is where things get interesting with credit card interest expense. If you are running a business, function as an independent contractor, or are otherwise self-employed – you can deduct credit card interest as a business expense.

Credit Card Interest as a Business Expense is Tax Deductible

For the sake of accounting clarity, it may be best to use a separate credit card for business related purchases, as in this way you can simply refer back to your monthly statements to calculate the amount of interest expense to deduct during tax season.

However, it is not necessary to have a separate credit card for business purchases – though it will be necessary to compile accurate receipts that separate your business purchases from personal purchases and the associated interest expense that you will deduct from your business tax return. Remember – personal credit card interest expense is not tax deductible.

Another Strategy - The Home Equity Loan as a Replacement

Since interest expense on home equity loans is tax deductible, if you are in the position of owning sufficient equity in your home, it can make sense to utilize the proceeds of a home equity loan to pay off your personal credit card debt. In this way, you will be replacing non-tax deductible interest expense associated with personal credit cards with tax deductible interest expense associated with a home equity loan.

Additionally, the interest rate associated with a home equity loan may in fact be lower than the interest rate attached to your credit card debt. The IRS stipulates that interest expense on home equity loans up to $100,000 is tax deductible, and places no restriction on how an individual is allowed to use proceeds from a home equity loan.

Bear in mind, however, that a home equity loan is secured by the underlying asset, so in the event of default, your dwelling serves as collateral for the loan. Nonetheless, since the interest expense associated with a home equity loan is tax deductible, this option could prove worthwhile, and it is one worth discussing with your tax professional.