Deducting Business Interest From Personal Credit Cards

The case caught my eye because it involves a very common fact pattern:

A small business owner obtains credit cards in his/her personal name and uses it/them for business purchases and activities.

Question: Can the business deduct the interest on the credit cards?

I doubt that there is a tax practitioner out there that hasn’t deducted this, but a recent case points out minimum requirements in case the IRS challenges the deduction.

Let’s look at C.A. Simmons, TC Memo 2026-34.

I admit that I was expecting some technical dive into the interest deduction, but this case is not that. It is a reminder that one has to get to first base before being able to reach home plate. Strike out and the rest is meaningless.

Cathryn Simmons and her sister owned a specialty store (called Stuff) in Kansas City, Missouri. They had sold handmade and small-batch goods since 1996. As is too common, Stuff struggled to obtain credit in its own name, so the sisters used personal credit cards and loans to finance the business. They used QuickBooks for their accounting, and they did try to segregate the credit cards between those used for business and those used personally.  

COMMENT: I suspect most clients I have advised can remember my standard sermon:

·      Establish a separate business account. Business deposits and expenses go through the business account. Personal expenses do not. I understand that the bank is going to charge for a business account, and it might be cheaper to lean into a personal account. Do not do that. You already incurred that expense when you started the business.

·      I understand that you might not be able to get a credit card in the business name and may have to use a personal card. Use one card for business and the rest for personal. Do not intermingle the two.

·      If you are using a personal card, I might have the business recognize it as a loan from you. We will formalize it with a note, mention an interest rate and make some reference to repayment. Do not be surprised if the interest rate on the note is the same as the credit card.

·      Keep records of all business deposits and expenses. At a minimum, buy an expanding file and file the paperwork by month. When we finish the tax return for the year, combine the return and its paperwork into a file or folder for the year, and hold onto it.

Back to Stuff.

The IRS looked at the 2017 business return and 2017 and 2019 personal returns. They expanded the business audit to include cost of goods sold, advertising, vehicle expenses, travel, meals and entertainment, charitable and promotion, and interest. We will discuss only the interest deduction today.

Stuff field a partnership return, and each sister’s share of the 2017 business profit was less than $3 grand.

There was a little chop with the interest deduction because it included both interest on the credit cards and interest on the personal loans. I point it out because the Court says the following about the personal loans:

As an initial matter, … fails to establish that the purported interest amounts Stuff paid to her and her sister arose from Stuff’s own indebtedness. The record contains promissory notes … but no ‘loan papers’ establishing Stuff’s indebtedness to the sisters.”

… we cannot conclude from these payments and the sisters’ testimony that Stuff had an actual legal obligation to pay interest to them.”

I get it but … harsh. I suppose Stuff was not following the terms of the promissory notes. We would - of course - redraft the terms of the notes. This is low hanging fruit.

What about the credit cards?

Ms. Simmons likewise fails to demonstrate that Stuff was entitled to deduct the credit card interest and finance charges recorded on its QuickBooks account. The evidence shows that Ms. Simmons obtained and used credit cards in her own name to finance Stuff’s business expenses given its inability to obtain credit on its own. Ms. Simmons fails to show that any credit card interest and finance charges constituted Stuff’s own indebtedness rather than her personal indebtedness, and thus no deduction is appropriate.”

Stop. I am having a problem here, as I am quite aware of Reg 1.163-8T.

Seems to me that if (1) I trace a business expense from the credit card statement to (2) the QuickBooks, I have at least a good chance of meeting the requirement that “debt is allocated by tracing the disbursements of the debt proceeds to specific expenditures.”

Back to the Court:

Assuming arguendo that credit cards opened by Ms. Simmons constituted an indebtedness of Stuff, the records before us would not substantiate the amounts claimed. Although the sisters testified that they used the six designated credit cards exclusively for Stuff’s expenses, they failed to establish the amounts and business purposes of the underlying expenditures that resulted in the interest and finance charges at issue.”

They failed to establish the amounts and business purposes …?

I believe two things happened here:

(1)  Stuff could not document a lot of expenses. On quick review, I see the IRS disallowing almost $13 grand of vehicle expenses, $22 grand of charitable and promotion expenses, and so on.

(2)  If those expenses ran through the credit cards, then I understand an allocable portion of the interest being disallowed.

However, the Court just nixed the interest deduction altogether.

Seems to me that some of the credit card interest – that allocable to deductions allowed – should be deductible. I presume the accounting was not clean enough to do a side calculation. The IRS will rarely play forensic, and the Tax Court certainly will not.

The Court did reemphasize that it wanted to see linkage between the business activity and the credit cards, but that has been the rule since I have been practicing. There is nothing new here. Somebody just forgot to get on first base.  

Paying Tax Without Setting Foot In California

 

I expect that many tax practitioners would consider state taxes to be a bane in their professional practice. I – unsolicited and without trying – have known more than a few.

Let’s limit our discussion to state income tax.

Mind you, we are not discussing the right of a state to tax. I practice within a Tristate area (Indiana, Kentucky and Ohio) and all three states impose business and personal income taxes. Yes, it can get messy. Take bonus depreciation, for example. This is a federal tax provision allowing the accelerated deduction of equipment and similar asset purchases. Some states will follow along with the federal treatment, others will ignore it completely, and yet others will have some odd hybrid. Take a relatively simple business return with activities across multiple states, and depreciation alone can raise the difficulty level of the return.

Mind you, some states are user-friendly with their tax laws (at least, as much as possible), but some states do not even pretend to be.

I am going to crimp from a notorious California tax case, changing the underlying taxpayer just a smidge to someone you will recognize.

Let’s take a partially retired Cincinnati tax CPA. He has several California clients, both business and personal. He consults, prepares returns and assists with tax agency correspondence and issues.  He of course invoices for his work, and some of those California clients issue him a Form 1099 to memorialize the payment. Critically, he never sets foot in California, and he has not for decades.

Does our Cincinnati tax CPA need to file a California income tax return?

Let’s walk through this.

The California Franchise Tax Board (FTB) annually matches 1099s to filed returns to identify individuals who may not have filed required California returns. The FTB saw those California-origin 1099s and contacted our valiant protagonist, who explained that he did not live in California, had not been in California in years, and – given its current deterioration – had no intention to ever visit California for any reason.

The FTB rejected his explanation, explaining that he had performed services for California businesses and thus had California-source income. The FTB sent a Proposed Assessment for tax, penalty and interest.

Our scrappy hero protested the assessment.

The Office of Tax Appeals (a/k/a Vought) decided as follows:

California imposes a tax on the taxable income of every nonresident, broadly defined as “gross income and deductions derived from sources within this state.”

There is no dispute that appellant, as owner of a sole proprietorship … conducted his … business as a sole proprietor.”

Regulation 17951-4 does not define the term ‘unitary business,’ but the definition can be inferred from Regulation 17951-4(b) … applying to a nonresident’s business, trade or profession … conducted partly within and partly without the state, where the part conducted within the state and the part conducted without the state are not so separate and distinct from and unconnected to each other to be separate businesses, trades or professions.”

Here, appellant … conducted a one-service business …. Therefore, we find that appellant was conducting a unitary business.”

What is the point of all this gum flapping?

California wants to apportion the California invoices to California. They do not even care if you were ever there.

Under the statutory grant of authority of R&TC section 25136(b), the FTB promulgated Regulation 25136-2, which provides detailed market-based sales factor sourcing provisions that implement and interpret R&TC section 25136.”

Pray tell, oh Oracle. How shall R&TC section 25136 be interpreted?

Regulation 25136-2(c) states that sales from services are assigned to [California] to the extent the customer of the taxpayer receives the benefit of the service in [California].”

Here is the wrap:

       

I do not mean to distract the lofty legal minds at the big-building-with-marble columns, but don’t you have to start with more-than-one if you are uniting down to one? Is there a trick-of-the-language thing happening here? Asking for a friend.

The case we are discussing (with some literary license) is Appeal of Bindley (CA OTA, May 30, 2019, No. 18032402).

What got me thinking about Bindley is the (very) recent case of Xavier Garcia-Rojas v FTB, A172054, CA Ct of Appeal, First Appellate District, Division Three, 5/1/26.

Garcia-Rojas was a radiologist from Texas. He read images from around the nation, some of which came from California. The FTB wanted its pound of flesh, relying on Appeal of Bindley above.

This is, BTW, how bad tax law metastasizes. The first court misses the pitch altogether, and the next court just piggybacks.

The Court fortunately recognized the issue:

Here is the decision:

Bindley held that a “self-employed screenplay writer” in Arizona was a unitary business, and thus could be taxed under regulation 17951-4(c). (Bindley, at pp. 1, 4–5.) But in doing so, it focused on the tests to determine whether two different businesses are unitary. (Bindley, at pp. 4–5.) It ignored that there must be separate business activities to unite. (Ibid.; Bunzl Distribution USA, Inc. v. Franchise Tax Bd., supra, 27 Cal.App.5th at p. 991.) The Board also relies on regulation 25120, subdivision (b), but that regulation states it applies only if there are “two or more businesses of a single taxpayer.” Thus, the Board failed to show that Garcia-Rojas is a unitary business as a matter of law.

It took it a while but they eventually got it right. This did not help Bindley, however, who was robbed on an issue a second-year accounting student could spot.

This seems to be an awful lot of work just to determine if our winsome-CPA-hero-of-the-story needs to file a nonresident California tax return. It is also why many CPAs consider state tax to be the bane of their practice.