A small business loan can have a big impact on your taxes — in a good way. One little-known perk is that small business owners may be able to deduct their interest payments on their taxes.
That’s right: business loan interest can be tax deductible.
Here’s what small business owners should know about interest deductions and small business loans. But remember: Business taxes are complicated. This article is for informational purposes only and cannot be relied on as tax advice. You should consult with a tax professional, such as a CPA or a lawyer, in determining which of your specific expenses may be deductible and how to deduct them on your return.
Is the Interest on My Business Loan Tax Deductible?
It’s possible that the interest you’re paying on your business loan is tax deductible. This means that you may be able to subtract that amount you paid in interest from your business income, which could, in turn, help you lower your tax burden.
However, this doesn’t mean that the full amount of a loan repayment can be deducted — it’s only the interest. For example, if your loan payment is $1,000 and $700 of that goes to the principal balance and $300 goes toward interest — you may be able to deduct the $300 from your taxable income.
How Do I Know if I Qualify for a Business Loan Interest Tax Deduction?
According to the IRS, there are some basic qualifications you need to meet in order to be eligible for a business interest deduction on your taxes.
- You must be legally liable for the loan.
- You must have a true debtor-creditor relationship (meaning you got the loan from a bank or financial institution — not family and friends).
- You and the lender must both intend for you to repay the loan.
Additionally, you must actually spend the money you received from the loan. Even if you’re paying the interest and principal on your monthly payments, if the funds you received are just sitting in a bank account you can’t write off the interest paid as a business expense. The reason for this is the money would be considered an investment and not an expense.
What Type of Loans Have Tax-Deductible Interest Payments?
You may be able to deduct the interest expense with nearly every type of business loan. The amount you may deduct and when can depend on things like your repayment schedule, how the interest is calculated and factors that relate to your specific situation.
Term Loan. A term loan is probably what you think of when people say “business loan.” You’ll get all the funds up front and repay it over a period of time with scheduled payments (such as, for example, monthly payments). The amount of interest paid is based on the APR for the specific loan.
Each payment you make on a term loan is split between interest and the unpaid principal balance based on an amortization schedule.You typically pay more interest during the beginning of your repayment period, but it’s likely you’ll be paying interest throughout the life of the loan — which means you may be able to deduct the amount of interest paid each year.
Small Business Administration Loans. SBA loans are loans that have been partially guaranteed by the Small Business Administration — they’re typically structured like a standard term loan. That means that the interest paid during the year on a SBA loan may be tax deductible each year.
Short-term Loan. A short-term loan is a term loan, but as the name suggests it has a shorter term. Most short-term loans are paid off within a year. This means that depending on when you take the loan out you may either be able to deduct all the interest paid on one tax return or perhaps over two tax years.
Business Line of Credit. A business line of credit is a form of open-end credit that is somewhat similar to a credit card. It allows a business to borrow, pay back and reborrow on a line of credit repeatedly, up to a certain credit limit. Typically, interest is charged on the amount borrowed. The interest charged will likely be identified on your account statements.
Personal Loan. If you take out a personal loan and some of the funds are used for business purposes, you may be able to deduct a portion of the interest. Someone who is self-employed may not want to rely on a business credit score, or they may need to buy something that’s for business and personal use — like a car that’s used to help them run their business as well. Just keep in mind that the interest deducted must be proportional to the amount that was spent on business versus personal expenses. A tax advisor can help you determine if you can deduct interest paid on a personal loan as a business expense
When Can’t I Deduct My Interest?
Refinancing. If you refinance your business loan you may not be able to deduct any interest from the first loan that was paid with the second loan. However, when you start making payments on the new loan you may be able to deduct the interest you pay on that.
Fees. When you take out a loan to purchase real estate, the points and loan origination fees generally can’t be deducted if they’re not considered a business expense. Instead they may be added to the total value of the property and get deducted with asset depreciation.
Capital Interest. Capital interest is interest that’s added to the principal balance because you’ve missed or skipped a payment. It may not be deductible as a business expense.
Unused funds. Generally, in order for the interest you pay on a loan to be tax deductible, you must actually use the funds for business purposes. If the funds simply sit in the bank, they’re considered an investment and not a business expense.
What Are Some Other Tax Deductions That Small Businesses Owners Should Be Aware Of?
As a business owner, there are a lot of tax deductions you can take advantage of. Here are two interesting cases.
Investment Interest Expense. Investment interest is the interest charged on money you borrowed to buy property or real estate as an investment. It doesn’t count as mortgage interest because you’re not buying or redoing your home. Typically, only the interest on the portion of the borrowed money that was invested may be deducted.
Tax-Deductible Expenses. You may not be able to write off all of your loan repayment, but what you spend the money on may be a tax-deductible expense. If you bought equipment, real estate or covered operational costs you may be able to deduct those items.