I am working with a client as we prepare for their IRS audit and an issue that has become very common to many businesses in this economy. Credit cards are frequently being used to finance the operations of a business. This may be due to limited cash flows for slow paying customers, no other available resources for funds or unexpected expenses. The credit card is used with the promise “I’ll pay it off when ____ happens”. But instead another problem arises or the expected payment is delayed. So a balance forward is now on the card or cards and now finance charges are being to accumulate.
How does the IRS want you to handle the finance charges? It will depend on a couple of factors. The best answer is that the credit card is used only for business transactions. There is no personal expenses on the card. And you have all the invoices and support to show this. This is the perfect situation and the interest expense will be deductible.
Suppose you use the business card for a couple of lattes at Starbucks while at the mall. And the card is not paid off at the end of the month. Now that personal interest is mixed in with the business charges. Now it become almost impossible to be able to deduct those finance charges on your tax return due to the way the credit card calculates the interest charges.
How can you avoid a business expense that cannot be deducted? Couple of ways:
1) maintain separate checking and credit cards for your business. This is also a key factor for hobby loss questions for horse businesses.
2) develop a budget and update it quarterly to help identify your cash needs at various times during the year. It can be fun to plan and ultimately be in control of where your business is going.
3) bill more often or diversify to increase cash flows. Bill every two weeks or think of other items you can do to increase cash flow each month. Spend some time brainstorming some ideas that fit your business. I find it is helpful to leave my office and spend some time pondering how and where the business is going. Kinda a mini retreat for myself.
Not only will the above tips improve cash flows, you will end up “saving” money as the credit cards interest rates keep increasing.