How Credit Cards Can Affect Your Taxes

For most people, tax time is stressful.  They are trying to get their financial information in order, but the tax code is so ridiculously complex that there are bound to be a few things that get overlooked.  Most people focus on W-2s, 1099s, and purchases and expenses that they could possibly write-off on their taxes.  But what about credit cards?  How do the purchases that you make with your credit card affect your taxes?

Some people use their credit card for business-related purchases and other transactions that they can write off on their taxes.  Some business-related cards offer rewards programs that give cash-back bonuses to business-people.  However, it doesn’t matter if a credit card is specifically for business or not: using one single card for all business-related transactions is just a simple way to make sure that all the transactions that will affect your taxes are located in one place.  This makes it easy to see the that there is a definite paper trail between your tax returns and your purchases.  This is helpful for simplifying your paperwork, lowering your tax prep time (or the billable hours that your accountant spends on your taxes), and for making sure that a paper trail exists in case you get audited by the IRS.

By now, everyone knows about using credit cards to pay your taxes.  Making payments with plastic is, of course, one way to avoid getting hit with a bill that takes you a year to recover from.  There is usually a small fee associated with credit card payments to the IRS.  However, paying taxes with credit is not the only way to spread your payments out over the year.  You can set up monthly or quarterly payments with the IRS that can split up your tax bill.  If you can’t pay all at once on April 15th, you can also contact the government to set up some sort of payment plan for the amount you already owe.

One of the nastiest surprises from the IRS is a tax that follows all recently-canceled debts.  The government treats debts that have been canceled (i.e. what happens when you settle with the credit card company) as income.  So anything that you owe but don’t have to pay back to the credit card company is taxed as earnings.  This can be a nasty surprise for people who thought that they had turned their fortunes around and done the right thing by settling with a credit card company.

Interest payments made on credit card accounts are not deductible, with one exception, interest on balances created by business-related transactions (where the transaction is deductible).  This is yet another reason to keep any work-related purchases separate from personal purchases by using a business-only credit card.

What about credit card rewards.  Wouldn’t it be a bite if your rewards were treated as income and all that work you did earning them gets canceled out by a tax payment?  The precedent for this situation has to do with airline miles accrued via credit card rewards program. Basically, the government considers these rewards “rebates,” not cash, so they do not have to be claimed as income.  Unfortunately, this is kind of a gray area, with most people able to claim any type of award as a rebate, even though some perks are more like cash than “rebates.”  If unsure, it is best to seek out the advice of an accountant who can at least explain the current tax laws to you and at best, help you if your rewards lead to an audit form the IRS.  Fortunately (or is it unfortunately), most rewards program gains are quite small, so they are unlikely to draw any attention.

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