Whether you have a business loan or are considering taking out one to finance your company, you have to be aware of the tax implications. In other words, is a business loan tax deductible? We have great news. A business loan, regardless of its amount or purpose, is not considered business earnings or income for tax purposes. Therefore, it won’t affect the amount you owe to Uncle Sam.
But it gets better. You can actually reduce your taxable income and what you owe in taxes by deducting the amount you pay in interest.
This is good news for any business owner and an advantageous opportunity to pay less tax and realize more profit.
Keep in mind, an exception relating to taxable income would be loan debt that’s forgiven by a creditor because a business couldn’t repay the loan. Creditors report the cancellation of debt on Form 1099-C as income and it would be taxable.
Continue reading to find out the requirements to get a tax deduction on business loan interest, when interest isn’t tax deductible and how much interest you can deduct.
Requirements to Get a Tax Deduction for Your Business Loan Interest
According to IRS Publication 535, you must meet the following requirements to get a tax deduction for business loan interest.
- You are legally liable for that debt.
- Both you and the lender intend that the debt be repaid.
- You and the lender have a true debtor-creditor relationship.
Accordingly, if you make loan payments to family and friends that includes interest, you can’t use the interest paid as a tax deduction. The business loan must be acquired from a legitimate lender. Likewise, the money you received from a lender must be expensed toward a verifiable business expense such as equipment, inventory, or hiring more staff. If you simply keep the money in the bank without making business purchases, you can’t deduct the interest.
In What Situations Is The Interest Not Tax Deductible?
As with anything, you need to know the exceptions when business loan interest is not tax deductible.
- Financing an original loan: If you use loan proceeds from a second loan to pay off the first loan, you cannot deduct any interest you pay. However, when you start paying off the new loan, that interest is tax deductible.
- Loan origination fees paid: These types of fees aren’t business expenses and don’t qualify as deductions.
- Standby fees: Any interest included in a standby fee paid to a lender to secure a future loan can’t be deducted.
- Capitalized interest: Interest incurred for a long-term asset is not expensed as business interest but treated as capitalized interest and depreciated over the asset’s useful life.
How Much Interest Can You Deduct?
Most small businesses can deduct the total interest paid to an accredited lender within a given tax year. There may be additional requirements, so in any case, you should contact a tax professional for further details.
For example, should you have a loan that covers both business and personal expenses, you can only deduct the amount of interest that applies to business expenses. Let’s say you took out a $10,000 loan split evenly between business and personal expenses. In that case, only the interest paid on $5,000 can be deducted. You would need to keep thorough records to support the business expenses you actually paid.
Business loan interest is reported on different forms depending on your entity’s business structure. Sole Proprietors and Single-Member LLCs should use Schedule C, Partnerships and Multi-member LLCs Form 1065, and Corporations and S-corporations Forms 1120 and 1120-S.
You can keep up with the total amount of interest you pay by posting the sum to your interest paid expense account in your accounting system when you make the payment. Then, if a lender or bank sends a statement at the end of the year, you can compare the two amounts.
Treat Your Business to Working Capital in December
Do you see how beneficial this interest tax deduction can be for your business? Applying for a business loan may now be one of your must-haves to end this year and start the New Year right. And Camino Financial can help. The sooner you apply for one of our business loans before the New Year arrives, the more interest you can report on your tax return which means a bigger tax refund.
We tailor our microloans and small business loans to match your business needs. When you apply for one of our loans, you will be paired with a loan professional to guide you through the process and answer your questions. Our loan process is transparent, quick, and simple. Additionally, the whole process occurs online from beginning to end.
No collateral, credit history or Social Security Number is required, and after 9 months of making timely payments, you can graduate to a second loan for a higher amount at a better rate.
Apply today for one of our business loans and know instantly if you prequalify. Once approved for funding, you could have money in the bank in 2-4 days for a microloan and 3-10 days for small business loans. And don’t forget the important part. You can deduct the interest on your tax return when you meet the IRS requirements.
Additional Reading: Common Tax Deductions for Business Owners