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.  

AI Practicing Tax Law

 

I was working with a younger accountant this busy season who is a fan of AI in tax research. He uses it quite a bit. He also has a client who in turn has used AI to review his work. This has not amused my friend, and I understand he intends to fire the client.

Irony, methinks.

There has always been research in tax practice, and AI is just the newest and shiniest model on the lot. My concern about AI is that previous research alternatives did not invent answers - that is, hallucinate. This can be a problem, especially for a young(er) practitioner learning the ropes. An experienced hand may recognize when AI leaves the pavement. That is small comfort, as I question whether an experienced hand would rely heavily on AI.

As we have commented before: you don’t know what you don’t know.

Let’s look at the Clinco case.

Peter Clinco was an attorney in California. He mostly practiced real estate and business law. He was also an entrepreneur and spent much of his time running MedCafe Westwood, a restaurant and bar near the UCLA campus. It started off as a partnership, but over the years Clinco wound up owning the place by himself. MedCafe had approximately 60 employees but did not have strong accounting for sales and tips. This would become an issue.

Clinco personally prepared his 2015 tax return, although he filed it late (2018). He reported restaurant gross receipts of approximately $1.6 million, with enough expenses to show a net loss of $400 grand. We do not know whether filing late was an issue, but 2015 got pulled for audit. There were two areas on that return the IRS clearly wanted to look at:

• The restaurant
• Two rental properties

Why do I say “clearly?”  See a tax return the way I do: where are your subtractions – that is, your deductions? More specifically, where are your biggest deductions? That is where an auditor would want to look, because that is where the dollars – and audit adjustments – are.

The exam started in 2019, when Clinco was already quite ill. The accountant stepped in for Cinco, but this was after Clinco commented to the revenue agent that an estimated 10% of the restaurant’s revenues were in cash.

Clinco planted a bug in the auditor’s ear. The auditor responded by using a common-enough technique: comparing known credit (and debit) card transactions to reported cash transactions. While the ratios can vary (in this case, 90/10), it is a starting point. Sure enough, the auditor decided something was off and expanded her audit.

What does it mean to “expand”? Easy. She requested Forms 1099 issued to MedCafe. The IRS would have those as a matter of routine.

She also requested copies of bank statements.

COMMENT: The bank deposit analysis is virtually de rigueur for all Schedule C audits at this point (MedCafe was a Schedule C because Clinco owned 100%). The concept is easy: all deposits are income unless proven otherwise. Fail to prove otherwise and you have a problem. I had an audit – with deposit analysis – a few years ago. A son (my client) intermingled his business deposits with his father’s (both were contractors). Why? Who knows. It is not normal business practice; I had a difficult time understanding why he did this; the auditor had a difficult time believing either of us; and his foolishness made the audit much more difficult than it needed to be.

The IRS thought actual revenues were about $3.8 million – approximately $2.2 million more than the $1.6 million reported on the tax return.

Yep, you can see that train a ‘coming.

What was Clinco’s first line of defense?

COMMENT: Somewhere during this Clinco passed away. Technically the matter would have been pressed by his estate and agents.

Clinco challenged whether one of the early procedural steps - the Notice of Deficiency – needed to be signed by the IRS in fresh ink.

This is well-trod road with (very) low risk of victory, but Clinco’s attorney (Mr. Wagner) brought novelties to the party:

He cites ‘Cacchillo v Commissioner’ … as a case where the taxpayer challenged the validity of the notice of deficiency because it lacked an official signature. He claims we held the IRS’s failure to issue a valid signed notice of deficiency ousted us out of jurisdiction.”

Mr. Wagner claims ‘Cacchillo v Commissioner’ … overturned ‘Miller v Commissioner’ and ‘Tefel v Commissioner’ ….”

Here is the Court:

Neither of these cases exist as cited.”

OK.

There is no case named “Tefel v Commissioner …”

Going down folks.

The bouillabaisse of case names, reporter citations and legal propositions suggests something cooked up by AI.”

Hard landing imminent.

Their presence is unacceptable.”

So…  I would say that the IRS was not required to hard-sign the Notice of Deficiency.

On to the audit adjustments.

Cash deposit analysis is a long-standing technique. The Court granted an adjustment when Clinco could prove that a deposit was not income, but it was not going to reject the entire analysis.

Even money-losing businesses, however, can have unreported income.”

There was one more issue.

The IRS wanted some proof for depreciation expense on two rental properties.

Normally, this is not outrageous to provide. One gets a copy of the closing statement. Sometimes the municipality itself maintains those records. Granted, it may not show later improvements and whatnot, but it is a start.

Clinco went in a different direction. Clinco argued that the IRS could not challenge depreciation because they had allowed it in a different tax year.

Folks - with minimal exceptions - this is not the way it works. The IRS not asking about your “fill-in-the-box” deduction in year one does not mean they cannot ask about it in year three. This is long-standing practice and predates me being in school.

Even AI should have picked that up.

Our case this time was Peter L. Clinco, Deceased, C. M. Barone-Clinco, Successor in Interest, and C. M. Barone-Clinco, T. C. Memo. 2026-16

A Skeleton Return And Portability

 

The amount for 2025 is $13.99 million.

This is the lifetime exclusion amount for combined gift and estate taxes. You can give away or die with assets up to this amount and owe neither gift nor estate tax. This amount is per person, so – if married – you and your spouse have a combined $27.98 million.

Next year that amount resets to $15 million, or $30 million for a married couple.

Let’s say it: most of us do not need to sweat. This is a high-end issue, and congrats if it impacts you.

What I want to talk about is the portability of the lifetime exclusion amount.

Tax practice brings its own acronyms and (call it) slang.

Here is one: DSUE, pronounced Dee-Sue and referring to the transfer of the lifetime exclusion amount from the first spouse-to-die to the second.

Let’s use a quick example to clarify what we are talking about. 

• Mr. and Mrs. CTG have been married for years.
• They have not filed gift tax returns in the past, either because they have not made gifts or gifts made have been below the annual gift exclusion. The exclusion amount for 2025 is $19,000, for example, so only a hefty gift would be reportable.
• Mr. and Mrs. CTG have a combined net worth of $20 million.
• For simplicity, let’s assume that all CTG marital assets are owned jointly.

 At a net worth of $20 million, one might be concerned about the estate tax.

Except for one thing: we said that all assets are owned jointly.

Let’s say that Mr. CTG passes away in 2026 when the lifetime exclusion amount is $15 million. His share of the joint estate is $10 million ($20 million times ½), well within the safety zone. There is no estate tax due.

Let’s go further. Let’s say that Mrs. CTG dies later in 2026.

Her net worth would be $20 million ($10 million - her half - and $10 million from Mr. CTG).

Could she have an estate tax issue?

First impression: yes, she could. She exceeded the lifetime exclusion amount by $5 million ($20 million minus $15 million).

In income tax we are used to numbers being combined when filing as married-filing-jointly. This is estate tax, though. That MFJ concept … does not apply so neatly here.

We can even create our own tax headache by having the first-to-die leave all assets to the surviving spouse.

And there is the point of the DSUE: whatever lifetime exclusion amount the first-to-die doesn’t use can be transferred to the surviving spouse. In our example, $5 million ($15 million minus $10 million) could be transferred. If Mrs. CTG dies shortly after Mr. CTG, her combined exclusion amount would be $20 million (her $15 million and $5 million from Mr. CTG). Since combined assets were $20 million, there would be no estate tax due. It’s not quite the simplicity of married-filing-jointly, but it gets us there.

Moving that $5 million from Mr. CTG to Mrs. CTG is called “portability,” and there are rules one must follow.

The main rule?

          A complete and properly prepared estate return must be filed.

Practitioners who work in this area know how burdensome a complete and properly prepared estate tax return can be. The return requires full disclosure of assets and liabilities, including descriptions and values, not to mention documentation to support the same. Here are a few examples:

•  Do you own stock? If yes, then each stock position must be valued at the date of death (or six months later, an alternative we will skip for this discussion). How do you do this? Perhaps your broker can help. If not, there is specialized software available.
•  Do you own 401(k)s or IRAs? If so, one needs to know who the beneficiaries are.
•  Do you own a business? If so, you will need a valuation.
•  Do you own real estate? If so, you will need an appraiser.

Let’s be blunt: there are enough headaches here that someone could (understandably) pass on filing that first-to-die estate tax return.

Fortunately, the IRS realized this and allowed a special rule when filing an estate tax return solely for DSUE portability.

Yes, we see the usual tax gobbledygook, but the IRS is spotting us a break when preparing the Form 706. 

• You can use (good faith) estimates. You do not have to hire appraisers and valuation specialists, for example.
• However, the special rule only applies if all property goes to the surviving spouse (the marital deduction), to charity (the charitable deduction), or a combination of the two.

Can you fail the special rule?

Yeppers.

Let’s look at the Rowland case.

Fay Rowland passed away in April 2016. She did not have a taxable estate.

The surviving spouse (Billy Rowland) passed away in January 2018. He did have a taxable estate.

Note the fact pattern: they will want to transfer Faye’s unused lifetime exemption (that is, the DSUE) to Billy, because he is in a taxable situation.

Fay’s Trust Agreement (effectively functioning as a will) instructed the following:

• 20% to a foundation
• 25% to Billy
• The remainder to her grandchildren

Fay filed an estate tax return reporting everything under the special rule: showing zero for individual assets but a total for all combined assets.

Billy’s estate return reported a DSUE (from Fay) of $3.7 million.

The IRS bounced Billy’s DSUE.

Off to Tax Court they went.

The Court agreed with the IRS.

Why?

Take a look at the special rule again.

• Assets passing to Billy qualify as a marital deduction.
• Assets passing to the foundation qualify as a charitable deduction.
• Assets passing to the grandchildren …. do not qualify for the special rule.

Fay’s estate tax return showed all assets as qualifying for the special rule. This was incorrect. The return should have included detailed reporting for assets passing to the grandchildren, with simplified reporting for the assets passing to Billy or the foundation.

Fay did not file a complete and properly prepared estate return.

The failure to do so meant no DSUE to port to Billy.

Considering that the estate tax rate reaches 40%, this is real money.

What do I think?

I have seen several DSUE returns over the last year and a half. Some have been straightforward, with all assets qualifying for the special rule. We still had to identify assets and obtain estimated values, but it was not the same amount of work as a full Form 706.

COMMENT: Practitioners sometimes refer to this special-rule Form 706 as a “skeleton” return. Skeleton refers to one providing just enough information on which to drape a portability election.

Then we had returns with a combination of assets, some qualifying for the special rule and others not. This is a hybrid return: nonqualifying assets are reported in the usual detail, while assets qualifying for the special rule are more lightly reported.

Fay’s estate tax return should have used that hybrid reporting.

Our case this time was Estate of Billy S Bowland v Commissioner, T.C. Memo 2025-76.

Filing A Zero-Income Tax Return

Here’s a question:

Would you file a tax return if you have no income – or minimal income - to report?

I would if there was a refund.

I also lean to filing if one has a history of tax filings.

The former is obvious, unless the incremental cost of filing the return is more than the refund.

The latter is because of my skepticism. I do not want a letter from the IRS stating they have not received a tax return for name-a-year. Granted, the issue should be easily resolved, but I have lost track of how many should-be’s have turned out to not-be.

Another reason is a rerun of Congress’ decision to automatically send advance payments back in 2021 – specifically, the child tax credit.       

You were ahead of the game by having filed a prior year return.

Ruben Varela filed a 1040EZ for 2017. It showed a refund of $1,373.

OK.

Ruben attached four Forms 4852 Substitute for Form W-2.

This form is used when an employer fails to send a W-2, among other situations. It happens and I see one every few years. But four …? That is odd.

The 4852’s that Ruben prepared showed zero wages.

And the $1,373 included Social Security and Medicare taxes., taxes which are not refundable.

Ruben, stop that yesterday. This is common tax protestor nonsense.

Let’s read on. There was third party reporting (think computer matching) for wages of $11,311 and cancellation of indebtedness income of $1,436.

Not surprisingly, the IRS considered it a protest filing and assessed a Section 6702(a) penalty.

§ 6702 Frivolous tax submissions.

(a)  Civil penalty for frivolous tax returns.

A person shall pay a penalty of $5,000 if-

(1)  such person files what purports to be a return of a tax imposed by this title but which-

(A)  does not contain information on which the substantial correctness of the self-assessment may be judged, or

(B)  contains information that on its face indicates that the self-assessment is substantially incorrect, and

(2)  the conduct referred to in paragraph (1) -

(A)  is based on a position which the Secretary has identified as frivolous under subsection (c) , or

(B)  reflects a desire to delay or impede the administration of Federal tax laws. 

That caught Ruben’s attention, and he disputed the penalty. On to Tax Court they went.

How can I owe a penalty if there was NO TAX, argued Ruben.

On first impression, it seems a reasonable argument.

But this is tax. Let’s look at that Code section again. 

              Such person files ….                                                      OK

              What purports to be a tax return …                                OK

      Does not contain information on

   which the substantial correctness …                             ?

 

Let’s talk about this last one. The Tax Court has a history of characterizing “zero” W-2s as both substantially incorrect and not containing sufficient information allowing one to judge the self-assessment of tax.

We have a third “OK.”

Back to Section 6702.

Is there any reference in Section 6702 to whether the return did or did not show tax due?

I am not seeing it.

The Court did not see it either.

They upheld the Section 6702 penalty.

The IRS wanted more, of course. They also wanted the Section 6673 penalty.

§ 6673 Sanctions and costs awarded by court

This penalty can be imposed when somebody clogs the Court in order to impede tax administration. The penalty can be harsh.

How harsh?

Up to $25 grand of fresh-brewed harsh.

The Court noted they had not seen Ruben Varela before nor was it aware of him previously pursuing similar arguments. They declined to impose the Section 6673 penalty, but …

We caution petitioner that a penalty may be imposed in future cases before this Court should he continue to pursue these misguided positions.”

The Court was warning him in the strongest legalese it could muster.

Our case this time was Ruben Varela v Commissioner, T.C. Memo 2024-92.