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My wife has a home business selling clothes. She purchases all her inventory with a credit card but she also uses the card for personal expenses. I understand that on the IRS Shedule C, we can write off credit card interest related to business expenses but how can I figure out what is interest charged for the business expenses? Is there an accepted rule of thumb or formula I can use?

For estimates sake, she started the year with a $20,000 balance on the card and ended the year with the same $20,000 balance. During the year she used the card to buy $27,066.28 inventory, most of which she sold. She also used the card for personal expenses. She also made payments of about $1000 to $2000 a month on the card.

Since I know the exact ammount she spent on inventory, is there a way a can estimate what percentage of interest paid would apply to the business expenses?

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There is no rule of thumb that can be used to separate the amount paid in interest.

The reason why so much interest was paid was because when you don't pay it off each month the new charges immediately start being charged interest. There is no grace period when you carry a balance.

If you were carrying a balance before the business started then the interest on that first business purchase was charged interest, but that interest was only there because of the non-business debt.

Get a separate card, and only use that card for business. That way everything on that account can appear somewhere in the business records.

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    A separate card is probably the cheapest option, too; at least it terms of time. – jpaugh Jul 8 at 21:27
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    Complete separation of home and business is the only way to go. However I can guess that there's some reward scheme (airpoints/cashback/etc) where increasing the throughput benefits you. Don't let that temptation for reward deter you from doing it in an audit-able way. – Criggie Jul 9 at 3:05
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    @Criggie plus, the reward you get may be taxable or create other implications if it's being earned through business expenses – simonalexander2005 Jul 9 at 11:05
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    When I took a class on small business finance, they used the term "piercing the corporate veil" to describe this exact type of intermingling of personal and business expenses. It has been awhile since the course so I don't remember the exact implications, but it's all risk and no reward. It opens up your personal assets to being considered part of the business assets - very bad if the business goes bankrupt or is sued. Get a separate card! – lizziv Jul 9 at 16:01
  • @lizziv I wouldn't assume having a separate account would be enough to protect yourself in case the business goes bankrupt or gets sued. – NotThatGuy Jul 9 at 17:54
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Don’t use an estimate. Use a spreadsheet.

Banks charge interest that can be apportioned down to the cent for each card transaction.

If you have the dates and amounts, as well as the rules used for charging interest, enter them all into a spreadsheet. Check that the total interest you calculate matches the interest on the bank statement, then just sum the interest entries related to the business.

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    The problem is, you could claim that you paid off all your personal items on time, and so all the interest was on the unpaid business items. Obviously the IRS would look askance at this, but what is the correct procedure? I'm guessing the way to go would be to pro-rata it: business interest = (total interest x business purchases) / (total purchases). – TonyK Jul 9 at 14:05
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By utilizing the card for both personal and business expenses, the account itself is now intermingled in to both, so you cannot split apart the interest expense easily.

If you itemized the outstanding balance at the start of the year to delineate what percentage of the card is being used for business vs personal each month, you could apply that same percentage to the interest accrued each day. As you make transactions/payments on the card you will have to recalculate the percentage and the interest that applies at the end of each business day.

You will also need to itemize each credit/purchase on the account and for which outstanding balance the payment is going toward (ensuring that you cannot cross over between business and personal without it being considered additional capital investment... or embezzlement).

This is quite a bit of work and has a good chance of flagging for an audit anyway because the numbers you are providing as interest expenses for the business will not match with the numbers on the CC account.

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    the numbers you are providing as interest expenses for the business will not match with the numbers on the CC account This only comes into play in the first place after an audit has been initiated. – chrylis -cautiouslyoptimistic- Jul 8 at 23:53
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You should arrange for a separate card for personal and business use.

You are unlikely to be able to completely disentagle the two at this stage and will likely have to forego this tax break to date. You should run anything you do claim by a registered accountant for verfication, for business tax purposes an "estimate" based on some back of the envelope calculations is unlikely to cut it.

Depending on the exact structure of interest payments on your card, it may now be impossible to disentangle the interest due to personal and business spending. For example if there are any thresholds such as "first 1$k is interest free", "rates are capped at x% over y$" or "daily charge of z$ for balances greater than" then you won't be able to separate the amount of business/personal which contribute to this threshold or which days caused the threshold to be breached.

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This is an audit magnet.

The short answer is ”You don’t. You use separate cards.”

And I think you know that. And the IRS is going to take that viewpoint: “What the heck are you doing here!!!???”

It’s all about what you can justify to the IRS.

Suppose you carry $20,000, charge $1000 of company stuff and $1000 of personal stuff. And then you make a card payment of $1000. It paid off something, arresting the interest on that... but how do you apportion it?

Whatever you claim, you will have to be ready to defend it to the IRS in an audit. And they can be pretty arbitrary on mucky stuff like this. That’s why you don’t let your accounting books be mucky.

Your books should be separate anyway

The business should have a whole separate set of accounting books anyway - for income and expenses, assets and liabilities (debt).

Understand that in accounting, there’s a difference between a bookkeeping account (say 6001 Sales Income) and a bank account (Wells Fargo 123456789).

It’s perfectly possible for accounting accounts to reflect money that is physically mixed in a bank account. That’s not a deal-breaker. Since you’re a proprietorship/partnership, IRS doesn’t really care if the bank and credit accounts are commingled.

But it’s a bad idea.

You could fix this with impeccable bookkeeping (i.e. accurate recording of transactions which already occurred, which frankly, is what all bookkeeping is). But you’ll need to be really, really into bookkeeping to pull it off.

You need to have a set of accounting books that list every occurrence of income and expense. Sales 6/5 $46.00 .... purchase mix of T-shirts 6/8 $461.00. One of your expense items will be interest. Yu have to position yourselves (personally) as “the bank” loaning money to the business, and charging the business interest day by day, at the same rate the card charges you.

Every business also has assets (inventory of T-shirts $844.14; cash attributable to business $2311.80) and liabilities (credit card debt $1941.00). Notice the part where the business has both cash and debt.

So from time to time the business has to take some of its “cash attributable to business” and pay down its loan (in theory “from you”). That payment is actually 2 payments:

  • it’s an interest payment that is mandatory, and that posts as an expense, i.e. as a monthly payout. This is a total loss to the business; it’s money gone.
  • And a principal payment which changes the amount owed, and that posts as a change in assets/liabilities. (Both at once, since you’re paying it out of assets, but reducing liabilities, so on the balance sheet, it’s a net change of zero.)

Now if your head is spinning right now, then stop. You are not ready for the kind and detail of accounting that will be required to get away with deducting part of your credit card’s interest costs.

Because to do that, you’ll need to know when the business charged something, and when the business paid reasonable payments from its attributed cash to that credit card. Then you can compute balance day by day, and accrue interest day by day, and arrive at the interest actually attributable to the business.

Note that the business needs to post credit card payments, and the payments need to be reasonable. It’s allowed for the business to go deeper and deeper into debt “on paper” as long as it’s making reasonable payments like a person might.

And of course the business must show a profit in some years, or else like Amazon have a business model that shows they will make money eventually. Otherwise the IRS will disallow it as a business, and treat it as a hobby, at which point you can only deduct cost of goods sold.

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