As tax season approaches, it’s important to get started on your 2019 business tax preparation. This includes being smart about what tax deductions you can take on your business loans or personal loans, that were used for your business.
You can generally deduct the interest paid or accrued on your business loans during the tax year, with a few exceptions (see below). That includes interest paid on a loan from a bank, other financial institution or an alternative lender such as BFS Capital.
Interest paid on business credit cards, line of credit, a car loan (for a car used by the business) or real estate mortgage can also be eligible. The interest is deductible whether you used business or personal property for collateral.
What’s not deductible is the principal repayment amount. That’s because the borrowed funds are not considered income for the business since they are not earned. The principal repayment is simply paying back the money.
Consider your personal loans too
You may also deduct the interest from a personal loan if you used the monies for your business. For loans that are used for both business and personal expenses, you must divide the interest between the personal part and the business part and then only include the business portion on your business tax forms. It’s similar in fact, to the tax treatment of an asset that is split between business and personal use.
For example, if you use your car only for business, you can deduct all paid interest for that year. But if you drive it for both personal and business reasons you can only deduct the percentage of business use. For example, if you use your car 70% of the time for business and 30% for personal purposes, then deduct 70% of the interest for the car loan.
Though you can deduct the interest on a business loan, the deduction only starts when you spend the borrowed monies. If you just put the loan money in the bank, you can’t deduct the interest because in that case, it is considered an investment. However, you may be able to deduct the interest paid on the money as an investment expense.
Consult a tax expert to confirm the payments meet the qualifications for that type of deduction.
Some interest expenses are not deductible
Unfortunately, not all interest expenses associated with a business loan are deductible. Interest expenses that are generally not tax deductible:
- Interest on loans for overdue taxes or tax penalties (only C-Corporations can deduct this interest).
- Interest for loans to pay taxes or fund retirement plans.
- Interest for loans of more than $50,000 that are borrowed on a life insurance policy for business owner(s) or employees.
For more detailed information about deducting interest on business loans and other information on business deductions, see IRS Publication 535.
Additional IRS requirements
Note that the Internal Revenue Service (IRS) has specific requirements that loans must meet in order to be able to deduct the interest. According to the IRS Tax Guide for Small Business:
- You must be legally liable for that debt. Make sure you have paperwork for this transaction, such as UCC-1 financing statement that a creditor files to give notice that it has an interest in the personal property of a debtor.
- Both you and the lender intend that the debt be repaid. You should have proof you are making payments and that the lender is depositing the monies.
- You and the lender have a true debtor-creditor relationship. It’s beneficial to have paperwork that details the relationship.
If you’re ready to join other businesses that use financing to grow their company, our application takes less than five minutes to complete. We take a holistic approach to the application review process not offered by other lenders. Please note, this blog does not constitute tax planning advice. Be sure to consult your tax accountant for the latest updates on deducting interest expenses.
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