Although tax season isn’t the highlight of most people’s year, there are ways to take the sting out of filing your return.
Few people would say that tax season is their favorite time of year, especially small business owners with endless tasks to juggle. Unfortunately, taxes are unavoidable for you and your company—but that doesn’t mean you’re completely at the whim of Uncle Sam. Deductions can be your best friend when it comes to filing income taxes for your business, as long as you know what to write off and when it makes sense to do so.
If you’ve borrowed money to help spur your small business’ growth, you might wonder whether or not you can deduct the interest you’ve paid. After all, interest payments do have the look and feel of your usual business expense, even if they’re going toward servicing debt and not toward something more tangible, like new office equipment or inventory. Plus, loan interest can add up quickly, creating all the more incentive for entrepreneurs to find a way to make that money work for them at the end of the year.
The good news is that your business loan interest might be tax deductible. The bad news? It depends on how you got the loan, and what you’ve done with the money. As with most things tax-related, there’s no straightforward answer that works for every business. But there are a few ways to determine if your interest payments count toward your yearly deductions.
Is Interest on Business Loans Tax Deductible?
Interest on your business loans is, for the most part, tax deductible. The Internal Revenue Service looks at business loans the same way they approach small business credit card interest payments—they’re both fair game for deductions come tax time. Interest payments are business expenses, even if they don’t necessarily feel like they’re the same as your other monthly and yearly expenditures. In the eyes of the IRS, they’re one in the same. That can be great news if you’ve borrowed to fuel your company’s growth.
Deducting your business loan interest is a great way to reduce your tax burden. In fact, you’re leaving money on the table if you don’t deduct these expenses. Same goes for other business purchases, too. If you’ve spent money on supplies, services, inventory, or most other things that come as part of running a company, you’re likely going to be able to deduct what you’ve spent when you’re filing your tax returns.
There are a few important caveats to deducting business loan interest, however. Most have to do with the lender you’ve chosen, how you’ve borrowed, and what you’ve done with the money. After all, you’ll need to be sure (and potentially provide proof) that you’ve used the loan for your business, should the IRS want more information about your deductions. Thankfully there are a few ground rules to help you figure out whether or not you might qualify.
How to Know If You Qualify to Deduct Your Business Loan Interest
You’re more than likely going to be able to deduct some portion of your small business loan interest, so long as you’ve got a genuine business purpose for the loan you’ve taken out. The amount of interest you can deduct, as well as when you can deduct it, depends on loan factors like the amount of time it will take for you to repay your loan, how interest is calculated, and what you’ve used the loan for.
Here are a few of the most common determining factors to help you figure out your deduction strategy. And, as always, be sure to contact your accountant before making any tax-related decisions.
Term loans are your standard small business loan option. Lenders give you and your business a lump sum payment, for which you make scheduled payments of the loan amount, interest, and fees. The interest rates on these kinds of loans tend to accrue over a certain amount of time, which means that you can deduct against the interest paid in the year you’re filing taxes. If your interest payments shift in cost, you can modify the amount deducted on an annual basis. The same rules apply to Small Business Association (SBA) loans as well.
Business Line of Credit
A business line of credit operates differently than your typical loan, particularly with regard to how (and when) you pay interest. A line of credit allows you to borrow against a set amount of cash, and you only pay interest on the amount you’ve taken out. This means you can only deduct the interest payments you’ve made for the money you’ve used from your line of credit, rather than the line of credit’s total amount.
The interest on short-term loans is also eligible for tax deductions. You’ll likely pay off the entirety of your loan within a fiscal year (if not within a month or two), which means you’ll deduct all of the interest paid within the same year you took out the loan. This, of course, is barring any other case-by-case conditions. You’ll use the same calculations to determine how much you can deduct in interest payments as you would with a long-term loan.
Personal Loans for Business vs. Business Loans
Personal loans used for business purposes are a bit trickier. If you used a personal loan to fund your business, you may still be able to deduct some amount of the interest payments on your company’s tax return. You won’t be able to deduct the full amount, however, if you’re using a portion of your personal loan to fund your own individual expenses.
Say for example that you’ve purchased a truck with a personal loan. Although you do use the truck for some business purposes (let’s say 50% of the time you drive it), there are other instances in which you’re using the vehicle for your own needs outside of work. In that case, you can only deduct up to half of the interest payments made within the year. Note that similar rules apply for credit cards. The IRS doesn’t allow individuals to write off their own credit card interest, so you’re better off getting a business credit card and limiting all company-related purchases to that account.
Although tax season isn’t the highlight of most people’s year, there are ways to take the sting out of filing your return. Deducting your business loan interest payments, as well as other business expenses, can help offset some of what you’ll owe. As long as you know what’s eligible for a deduction and can pull together the paperwork to back up what you’ve claimed, you might end up making your tax return a little less painful in the process.