Small businesses often struggle to get credit. Banks want collateral, financial history, and revenue figures that newer or smaller operations cannot always produce.

When the business itself cannot qualify for a loan or a credit card, the owners step in. They open credit cards in their own names, charge business expenses to those cards, and treat the interest as a cost of doing business. It is a common arrangement. It can also be a tax trap.

The question is whether a business can deduct interest on debt that legally belongs to its owners. The tax code allows a deduction for interest on indebtedness. But whose indebtedness? If the credit card is in the owner’s name, the card issuer looks to the owner for repayment. The business may benefit from the spending, but the legal obligation is personal.

That distinction was at the center of Simmons v. Commissioner, T.C. Memo. 2026-34. The case provides an opportunity to consider how the U.S. Tax Court draws the line between a business’s debt and its owner’s debt—and what happens when that line is not properly documented.

Facts & Procedural History

Simmons and her sister ran a boutique store that sold handmade and specialty goods. The store had been in business since the mid-1990s. It was organized as a limited liability company treated as a partnership for federal tax purposes. Each sister owned a 50% membership interest.

The business had trouble obtaining credit on its own. Banks would not extend loans or lines of credit directly to the store. So the sisters did what many small business owners do. They applied for credit cards in their own names and used those cards to pay for business expenses. They tried to keep these cards separate from their personal ones to avoid mixing business and personal charges. Over time, the business carried significant unpaid balances on at least seven different credit cards. Six of the seven cards were in Simmons’s name alone. They had no reference to the business.

The sisters also lent money personally to the business. Some of that money came from family loans. In 2017, each sister entered into three promissory notes—two with a family trust and one with a family member—for loans totaling $22,500 per sister. On at least one occasion, the business made payments to the sisters that they then used to pay interest to their father on those family loans.

On its 2017 partnership return, the business reported $16,901 in interest expenses. This included both the credit card interest and finance charges and the amounts paid to the sisters for the family loan interest.

On audit, the IRS disallowed the interest deductions along with several other claimed expenses. The resulting notice of deficiency determined that Simmons’s distributive share of the partnership’s income should have been $224,078 rather than the $5,970 reported on her return. The IRS also determined a deficiency for the 2019 tax year and assessed an accuracy-related penalty for 2017. Simmons petitioned the U.S. Tax Court.

When Can a Business Deduct Interest?

Section 163(a) allows a deduction for “all interest paid or accrued on indebtedness within the taxable year.” That sounds broad. But the statute carries a requirement that courts have enforced strictly for decades. The interest has to arise from the taxpayer’s own indebtedness. A taxpayer cannot deduct interest that belongs to someone else.

This rule has real consequences for how businesses are structured. When a sole proprietor or a partner uses personal credit to finance business operations, the question of whose debt it is can dectate who gets the tax deduction and whether the deduction is even deductible. Unfortunately, IRS agents often do not care that the money was spent on business supplies or inventory. What matters is who is legally obligated to repay the lender. If the obligation runs to the individual and not to the business, then there is a position that the interest belongs to the individual.

The U.S. Tax Court has applied this principle consistently. In prior cases, the court has held that in the absence of an obligation of the taxpayer to pay interest, the taxpayer is barred from deducting interest notwithstanding the taxpayer’s characterization of payments as interest payments. The label does not matter. The legal obligation does, according to the court.

Does It Matter That the Cards Were Used for Business?

Many business owners assume that because they used a credit card exclusively for business purposes, the interest on that card is automatically a business deduction. That assumption is wrong.

The tax code does not look at how the money was spent when determining who owes the debt. It looks at who signed the credit agreement. That was the issue in this case. In this case, the sisters testified that they kept the credit cards used for business separate from their personal cards. They said they tried to avoid commingling business and personal charges. But the cards were in the sisters’ individual names. The business itself had no credit relationship with the card issuers. The credit card companies would look to the sisters—not the business—for repayment.

The court found that Simmons failed to show that the credit card interest constituted the business’s own indebtedness rather than her personal indebtedness. That was enough to deny the deduction. You can start to see the problem here. Even if every single charge on the card was legitimately for the business, the interest on those charges is still the cardholder’s personal obligation if the card is in the cardholder’s name.

The court did not address what the business might owe the sisters in return for using their personal credit. That question seems like a logical next step. When a business runs on someone else’s credit, the cardholder is taking on real risk and providing real value, and the law of third-party beneficiaries and related liability theories suggests the business has some obligation back to the cardholder. From there, an offset could follow. If the business should have paid the sisters a fee for the use of their credit and never did, that unpaid fee might support a deduction, a bad debt, or some other adjustment on the business’s side. The court did not extend its analysis in that direction.

The Substantiation Problem Made It Worse

The court went further in this case. It noted that even if it accepted that the credit cards constituted an indebtedness of the business, the deduction would still fail on substantiation grounds.

The sisters testified that they used the designated credit cards only for business. But they failed to establish the amounts and business purposes of the underlying charges that generated the interest.

The testimony did not resolve concerns about commingling. The sisters could not identify specific examples of spending on the cards. They could not offer a consistent explanation of how they ensured the cards were used only for business. And they could not provide evidence that would allow the court to estimate any deductions under the Cohan rule.

The IRS attorney also pointed out questionable transactions and inconsistencies between the QuickBooks entries and the actual credit card statements. Simmons offered no response. The court was left with what it described as “the sisters’ unsupported confidence that the credit card interest and finance charges stemmed only from business activity.” That was not enough.

This is worth pausing on. Even when a taxpayer clears the hurdle of proving that the debt belongs to the business, the taxpayer still has to substantiate the amounts. Inadequate records can sink a deduction at two levels. First, the taxpayer cannot prove the legal relationship. Second, even if the relationship exists, the taxpayer cannot prove the numbers. This can create a significant hurdle for taxpayers to overcome.

The trap in Simmons is one that catches a lot of small businesses. A business cannot get credit on its own. The owners step in, open cards in their names, and use them to keep the doors open. They pay the bills, track the expenses, and report the interest as a business deduction. It seems logical. The money went to the business. Why should the interest not follow?

According to the court, the answer is that the tax code distinguishes between economic reality and legal obligation. The fact that the money was used for business does not make the debt a business debt. The legal obligation to repay the creditor determines who can deduct the interest. If the credit card agreement is between the individual and the card issuer, the interest is the individual’s.

There may be ways to address this. For example, a business can apply for credit cards in its own name. When that is not possible or was not done—and for many small businesses it is not possible, by the way—the owners may be able to formalize the arrangement. A written agreement between the owner and the business, documenting a loan from the owner to the entity, might be used to establish the business’s indebtedness.

The Takeaway

The question of who owns a debt sounds simple. But for small businesses that rely on their owners’ personal credit, it creates a gap between how the business operates and how the tax code treats the resulting interest charges. This case shows what happens when that gap is not documented away. The business used the credit cards. The business paid the bills. The business recorded the interest. None of that mattered because the legal obligation to repay the creditors ran to the owners, not to the business. For small business owners who finance operations through personal credit, the lesson is straightforward. Document the lending relationship between yourself and the business. Without that documentation, the deduction might not be allowed if challenged by the IRS—no matter how clear it is that the money went to the business.

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