Credit cards are powerful tools, and almost 70% of small businesses use them each month.1 Understandably so, as they can help facilitate sales and purchases, separate personal and business funds, and build your business credit scores.
However, you don’t get all those benefits for free. You’ll have fees to pay whether you’re paying with credit cards or accepting them as payment from customers. Here’s what you should know about the tax-deductibility of those credit card fees for your business.
Are Credit Card Fees Tax Deductible for Businesses?
In general, credit card fees are tax-deductible for businesses. That’s true for both the costs you incur to own or use from a credit card account and any processing fees you pay to accept credit cards from customers.
Unfortunately, credit card fees are never tax-deductible as a personal expense, so you can’t write off anything that’s not directly related to your business. Because of this, it’s usually a good idea to get a separate credit card for each aspect of your finances.
If you use one credit card for both your business and personal transactions, you’ll only be able to deduct the business portion of that card’s fees. Sorting through your activities to prorate your credit card interest charges or annual fees can be a lot of work.
For example, say you start a new small business. Instead of getting another card specifically for business use, you pay for the company’s expenses with the same credit card you already use for your personal life.
At the end of the year, you’d have to comb through all your expenses, label them as either personal or business, and then calculate what percent of your spending was for your company.
You’d then multiply it by your annual fee to determine what you could deduct.
If your annual fee was $95 and half your spending on the card was for your business, you could deduct $47.50.
Finance charges would be even more work since you can only deduct an interest charge on a business purchase. If a credit card company bills you for a balance made up of personal and business expenses, it’d be hard to calculate the deductible portion.
Note that it doesn’t matter whether the account is officially a personal credit card or a business card. The purpose of your credit card charges determines the deductibility of the fees associated with the account.
If you have a business credit card and use it for personal transactions, nothing will be deductible. Conversely, if you have a personal credit card and use it exclusively for business expenses, everything would be deductible.
How To Deduct Credit Card Processing Fees
In 2021, you’ll probably find that your customers expect you to take credit cards as a form of payment. Consumers used credit cards to complete 27% of all their transactions in 2020, while cash was down to just 19%.
Unfortunately, that can be an expensive proposition due to credit card processing fees, which often include a flat monthly payment and a transaction fee of 1% to 4% on each credit card sale. Fortunately, these are always deductible for your business.
While the flat monthly payment is easy to track, the percentage-based processing fee can be harder to document. If you use your business’s bank statements for your accounting, you’ll only see your revenue net of your credit card fees.
The difference might not change your net income, but it changes your adjusted gross income, which determines your eligibility for tax credits and affects your contribution limits for retirement accounts.
As a result, it’s better to record your actual gross revenue and then deduct the processing fees separately. If you do, you can record the fees as part of your cost of sales or as an operating expense.
There are arguments for both, but it ultimately comes down to preference. Just make sure you stay consistent with whichever one you choose to keep your financial statements organized for tax season.
Depending on your business’s legal entity status, you’ll report them on the following tax forms:
- Sole proprietor: Schedule C (Form 1040). Put them on Line 4 if you follow the cost of sales method. If you treat it as an operating expense, you can put it on Line 10, Commissions and Fees, or line 27a, Other Expenses.
- Partnership: Form 1065. Put them on Line 2 as part of the cost of sales or Line 20 as an operating expense.
- C-corporation: Form 1120. Put them on Line 2 as part of the cost of sales or Line 26 as an operating expense.
- S-corporation: Form 1120-S. Put them on Line 2 as part of the cost of sales or line 19 as an operating expense.
If your business is a limited liability company (LLC), you’ll select the tax treatment of one of the entities above and report your business on the appropriate form.
Which Other Expenses Are Deductible for a Business?
In general, the Internal Revenue Service lets business owners deduct any expenses that are “ordinary and necessary” for their day-to-day operations.
An ordinary business expense is one that businesses similar to yours typically face. For example, if you run a restaurant, you can deduct the cost of your meats and vegetables. That’s an ordinary expense for any business that serves meals.
Conversely, it would raise some eyebrows if your restaurant tried to write off a sewing machine. That’s not something a restaurant would usually buy, and it probably wouldn’t hold up under an audit.
Necessary expenses are beneficial and appropriate for your business. For example, say you run a small delivery service. You’d need some means of transportation, so it would make sense to deduct some vehicle expenses.
That said, part of being a necessary expense is appropriateness. In other words, not every possible solution to a problem is a reasonable purchase or deductible business expense.
For example, if you bought an expensive luxury vehicle for your deliveries, you wouldn’t be able to deduct all of it. You could’ve gotten a less expensive vehicle to meet your needs.
Here are some other common small business tax deductions to be aware of:
- The home office deduction, if you work at home
- Rent and utilities for an external office space
- Depreciation on equipment or real property
- Merchant fees as either buyer or seller
- Interest payments on business debts
- Travel expenses for trips with a business purpose
- Liability, health, and auto insurance
The IRS doesn’t provide a comprehensive list of ordinary and necessary expenses, so it’s ultimately a judgment call. Just document all your purchases and make sure you have an argument for why each one qualifies as a deductible expense.
Once your business becomes sophisticated enough, it’s a good idea to hire a Certified Public Account (CPA) for guidance if you can afford one. Failing that, research the typical treatment for a specific expense if you’re unsure whether it’s deductible.
Don’t Make Purchases for the Deduction
Ordinary and necessary expenses like credit card fees are tax-deductible for your business, but you shouldn’t make purchases just because they’re deductible.
A tax deduction means you can discount a purchase by your tax rate, but nothing more. If you buy something only for the tax write-off, you’ll still end up losing money.
For example, say you’re a new business owner considering getting a credit card for your company’s transactions. It has a $595 annual fee, but you know it’s a deduction, so you figure it’s worth it.
If you decide to take out the credit card, you’ll pay a $595 annual fee and reduce your taxable income by $595. In other words, you won’t pay taxes on $595 of income. If your tax rate is 24%, you’d save $143 on your taxes, but that’s still a $452 net loss.
The lesson here is that you should consider the deductibility of purchases for your business, but remember that it’s just a discount. It should never be the only reason you buy something.
Once again, it’s usually best to work with a CPA or other qualified tax advisor to help you navigate your tax planning, including your deductions, whenever possible.
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