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Grabbing Your Interest

It may be of interest to you that a commonly missed deduction for taxpayers is interest. (That will be the only lame pun in this piece. I swear!)

What interest deductions are sometimes forgotten?

Car Loan Interest: For business owners, one often-overlooked deduction is interest on a car loan. Whether you deduct your actual car expenses or take the standard mileage rate, you are also entitled to claim a deduction for proportionate amount of interest on your auto loan for your writing business. For instance, if you drive 10,000 miles in a given tax year, 1,000 of which are business miles, and your car loan interest for the year is $500, you can claim an interest deduction of 1,000/10,000 x $500, or $50. The deduction in this example is small, but if you have a large percentage of business miles and/or a large car note, your deduction could be significant. Financial institutions are required to report your annual interest paid, so look for a statement in January.

Credit Card Interest: Credit card interest is another deduction business owners forget. Although interest on personal purchases is generally not deductible, interest on business purchases is. The IRS allows a deduction to businesses for supplies and other non-depreciable items in the year in which the items were charged even if the credit card debt is not paid off until a later tax year. The interest applicable to business purchases is deductible in the year in which the interest is actually paid. Credit card companies, too, are required to send a year-end statement showing the amount of interest paid, so be sure to keep it for tax purposes.

If you have a charge card you use for both personal and business purposes, it may be difficult to nail down exactly how much the interest charges were on the business portion of your charges. It’s simpler to have one card used strictly for business purchases so the end-of-year statement will provide the exact interest amount to deduct.

No-Interest or Below Market Interest Rate Loans: Think you got a great deal by buying a car, furniture, or other item on a zero-interest or low-interest loan? The IRS is a big buzzkill on these loans. According to Uncle Sam, in economic reality no lender makes interest-free or below-market rate loans. Per the IRS, the transaction actually involves a lower amount of principal than that stated in the purchase documents and includes “imputed interest” (a.k.a. “original issue discount”). The installment payments on the loan are treated for tax purposes as including an interest component.

Unless you are Good Will Hunting, the rules for computing the revised principal amount and the imputed interest could blow your mind. Talk to a tax pro if you have, or think you might have, a below-market interest rate loan. Those sadists among you can take a look at the discussion of original issue discount in Publication 535 “Business Expenses” on the IRS website, www.irs.gov.

And don’t forget, the depreciable basis of property purchased on a zero- or below-market rate loan will be the recomputed principal amount.

Personal Interest: As noted above, most personal interest is not deductible. A few items of personal interest are deductible, however, including mortgage interest on a personal residence, home equity loan interest on a personal residence, student loan interest, and investment interest.

These types of interest are subject to certain limitations and are reported in different places on the tax forms. Investment interest, for instance, is deductible only up to the amount of investment income, though the amount disallowed for a given tax year may be carried over to the next tax year. Investment interest is claimed on Schedule A. (See IRS Publication 550 “Investment Income and Expenses” for more details.) Student loan interest, on the other hand, is reported on page 1 of Form 1040 in the “Adjusted Gross Income” section. Student loan interest is subject to an annual maximum which is further reduced if the taxpayer’s income exceeds certain limits. (See IRS Publication 970 “Tax Benefits for Education.”)

Planning Tip: Because business interest is deductible and personal interest generally is not, you are better off charging business items rather than personal items if you have only a limited amount of cash with which to pay your expenses. For instance, let’s say you have only $100 cash. You need to buy both $100 in printer cartridges for your writing business and a $100 pair of booty-lifting jeans (after all, sitting in a chair all day writing isn’t great for the glutes). If you charge the jeans and pay cash for the printer cartridges, you’ll get no tax deduction for the credit card interest since the expense is personal. If you pay cash for the jeans and charge the printer cartridges, however, the interest on the charge would be deductible and thus reduce your taxes.

Likewise, if you have a large personal purchase to make and don’t have ready cash to pay for it, you may be better off taking a home equity loan rather than financing the purchase through another type of credit. While personal interest is generally not deductible, home equity loan interest generally is. Thus, you can turn a non-deductible interest expense into a deductible interest expense. Abracadabra! (See IRS Publication 936 “Home Mortgage Interest Deduction” for information about applicable limits.)

Diane Kelly’s debut novel, “Death, Taxes, and a French Manicure” will be released in September 2011. Sign up for her newsletter, full of tax tips and writing news, at www.dianekelly.com.

9 responses to “Grabbing Your Interest”

  1. Elisa Beatty says:

    Ooh–thanks for this, Diane! I am SUCH a dope when it comes to financial things….I keep thinking if I just close my eyes and don’t think about it, it will all go away. (And that’s exactly what happens to my money!)

    So home equity loan interest is *deductible*?? How do I even figure out how much I paid in interest each year–I don’t think I get any sort of statement from the bank. Or maybe it arrives during those times when my eyes are squeezed closed.

    And is it deductible for everybody, the way mortgage interest is, or does the loan have to relate in some way to a business (home office, etc.).

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    • Diane Kelly says:

      Yep, home equity loans are deductible regardless of whether they are business related. But only to the extent of interest on the first $100,000.00 of the home equity loan (one of those pesky limitations I referenced). The theory behind this is that you’ve essentially “bought” your house again, just like someone who sold their house and bought another.

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  2. Shoshana Brown says:

    Great tips, Diane. I had no idea about the no-interest loan stuff.

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  3. Laurie Kellogg says:

    One of the things my hubby and I have done in the past is take home equity loans to pay for personal use cars on which we can’t deduct the interest. Also, HE loans are frequently a lower rate of interest than car loans.

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  4. Kim Law says:

    Thanks, Diane! Great stuff! I knew some of it, but some I didn’t. Always love learning ways to save money!

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  5. Rita says:

    I talk to people all the time who insist writers cannot deduct business expenses- Printer cartridges, paper, new computer, travel all that good stuff until you are published. Please explain.

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    • Diane Kelly says:

      Those are the same people who insist the world is flat and the moon landing was a hoax. : ) As long as your writing constitutes a business, you can deduct all of your business-related expenses even if the result is a net loss. You can be a business as a pre-published author – you are just not yet a successful business (not at all unusual since landing that first sale normally takes years). I took a net loss on my writing business for about 10 years. But I also had lots of proof that I treated my writing activities as a business, not a hobby. If a writer can show they are taking their writing seriously, trying to make $ at it, submitting, that they belong to writing organizations and are trying to learn about writing, they will likely pass muster as a business. And not to plug myself, but in case anyone wants to learn more, I will be teaching an online tax class through the Carolina Romance Writers chapter in January. I am also teaching it now through the Mid-Willamette Valley chapter.

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  6. I was wondering about the credit card interest for business and you’ve answered it. Start asap, I’m going to save one card for my business only.

    I have a question. How do you keep this all straight?

    Thanks for sharing your knowledge. It so important we’re business savy too.

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    • Diane Kelly says:

      The easiest way to know how much credit card interest is allocable to your business is to get a separate credit card that you use only for your business. Otherwise, you are going to have to compute the interest on your personal card that applies to your biz purchases (which the IRS will treat as being paid off first). This can get hairy! You’d have to compute the interest on your biz purchases each month, deduct the interest portion from the “principal” portion, then for the next month compute interest on the biz portion (as reduced by the amount of the payment that was allocable to principal), and on and on until the principal amount is paid in full. Yikes!!!! : )

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