Americans are credit-card crazy. And few groups rely on their cards more than entrepreneurs, who often use them to finance start-up and expansion activities. That's too bad, since credit cards are among the costliest forms of business financing. What's more, plastic is likely to get pricier. Thanks to a U.S. Supreme Court decision last summer, there is now no limit on how much card issuers can charge for late fees and other penalties, warns Michael Donovan, a partner at the law firm Chimicles, Jacobsen & Tikellis, in Haverford, Pa. Now is a good time to assess--and reduce--your credit-card risks.
Do you use the same cards for business and personal purchases? If not, breathe a sigh of relief. But what if you've never maintained a Chinese wall between your two types of credit-card purchases? Then matters can get a tad complicated. "Business owners are allowed to deduct credit-card interest on business purchases, but consumers can't deduct personal interest charges," explains Richard M. Colombik, a lawyer and certified public accountant based in Schaumburg, Ill. If you're charging inventory purchases one day and your toddler's new tricycle the next--all the while carrying over monthly balances--it's tough to prove to the IRS just how much of your interest charges should be tax deductible.
Solution: Either pay off your balances each month and forgo the interest deduction or use separate cards for business and personal expenses.
Do you use one card for all purchases and rely on reimbursement arrangements between your company and personal coffers? Such arrangements can really wreak havoc at tax time. "Here's one possible scenario," suggests Harvey J. Berger, an associate partner at the Washington, D.C., office of accounting firm Grant Thornton. "You're a 100% shareholder in a company that reimburses charges you've made on your personal card. If the IRS decides that these weren't legitimate business expenses--and that, instead, the reimbursement amounted to a dividend payment--you'll lose the tax deduction on any interest charges and get socked with corporate taxes, personal income taxes, back-interest charges, and maybe even a penalty."
Solution: Business owners shouldn't use the same personal card for individual and business purposes. If your company can't qualify for a corporate card, have one personal card that you use solely for business. If you do have a corporate card, it's somewhat less risky for you to reimburse your company for personal charges on it, but "you've got to keep these transactions squeaky-clean to avoid IRS challenges," warns Berger. Write a personal check each month for such a reimbursement.
Do you shop around for the lowest-cost deal? Too many businesses focus on getting the highest possible credit limit. That can be a costly mistake.
Solution: Spend a few moments analyzing, on paper, the three factors that relate to your credit picture--your required credit limit, your payment patterns, and your special "challenges." Be honest here: if you're typically late on several payments each year, it's smart to shop around for low late fees as well as low interest rates.
Do you document everything relating to business charges? If so, the IRS has probably already awarded you sainthood. If not, get your record keeping in shape before a tax auditor discovers your foibles. "I can't tell you how much money and time business owners waste when they--or their CPAs or lawyers--have to hunt through old records to try to figure out what a credit-card charge was for," comments Berger.
Solution: Document the who, what, where, when, and why of all your corporate charges. Take special care with typical IRS targets like travel and entertainment, as well as with expenditures that might blur personal and corporate lines. Keep the records for three to five years.