When it comes to your taxes, interest is a deductible expense for your business. This is great news for those business owners who have taken out a loan to grow the business with interest added on top. However, it is important to note that there are limitations and restrictions as to how these deductions can be applied depending on how business loans are used.
What Is a Business Interest Expense?
A business interest expense is the cost of interest on a business loan used to maintain business operations or to pay for business expenses. Its purpose is the ability for the expense to be deductible. In order for the loan interest to be deductible, the loan needs to be used to pay for business expenses or to purchase business assets. In the case that any portion of the loan is used for nonbusiness purposes, the amount of the deductible interest from the loan must be reduced.
What to Know About Business Loan Interest Deductions
In order to be eligible for the business loan interest deduction, there are some criteria you must meet as defined by the IRS.
- The relationship between you and the lender must be true (family and friends do not count)
- You are legally liable for the debt
- You and the lender intend for the debt to be repaid
The funds you have must be used for business purposes and not just sit in your bank account. If the funds just sit in your bank account, they will not be eligible for a deduction. You can deduct any interest accrued and paid during the fiscal year as long as you are liable for the debt. To qualify, the paperwork on file needs to be in your name and show the terms you report. Additionally, you must make regular payments and the relationship between you and the lenders must be legitimate.
When Business Interest is Not Tax Deductible
- When you refinance your business loan, it is not tax deductible. They become deductible after you start making payments on a new loan.
- You cannot deduct capitalized interest
- You cannot deduct fees incurred to have funds on standby
- You cannot deduct interest on loans used for personal purposes
- You cannot deduct on debt your business does not own
How Business Loans Affect Tax Deductions
No matter what kind of business loan you have, the interest can be deducted. There are four common loan types that allow you to get a tax deduction.
- Term Loans: You can deduct the interest that you paid during the tax year and do so until your loan reaches maturity. Term loans are structured, so you pay interest towards the beginning of your repayment schedule meaning you get larger deductions upfront.
- Short-Term Loans: Short term loan interest can be calculated through a standard APR or a factor rate. Speak with your lender to determine the exact interest rate so you know what you will be deducting when it comes to tax time.
- Business Lines of Credit: the size of your deduction on your interest with a line of credit depends on the amount that you use.
- Business Acquisition Loans: it is likely that you can deduct part or even all the loan’s interest if you used a loan to acquire a business.
- Personal loans: if you use a personal loan and mix it with business use and personal use, then the position of the interest that is tax deductible is proportional.
When Is Interest Not Tax Deductible?
There are a couple cases where interest on business loans is not tax deductible. If you pay off a loan to the original lender with the funds from a second loan is not a business expense. This means the interest you are paying to the first lender is not tax deductible. You can deduct the interest again once you start to pay off the new loan.
The points and loan origination fees are not considered business expenses and cannot be deducted. The costs must be added to the value of the property and deducted over time with asset depreciation.
Interest for loans to pay taxes or fund retirement plans and interest for loans of more than $50,000 that are borrowed on a life insurance policy for business owners or employees.
The Bottom Line
If your loan is being used for business purposes, the interest will be tax deductible but in some certain situations it is not deductible. If you still have questions about business loan payments being tax deductible, consult with a tax professional to help you answer your questions and ensure that you maximize a business loan interest deduction and save money.