Is a Business Loan Considered Taxable Income? What Small Business Owners Need to Know

Starting and growing a small business often requires capital beyond what the owner has on hand. Many entrepreneurs turn to small business loans to fund expansions, equipment purchases, real estate acquisition, and other investments in the company’s future. But does taking out a loan count as taxable income for the business?

The short answer is no—with a few caveats. Let’s break down when business loan proceeds do and don’t count as taxable income, as well as how these loans can impact your taxes in other ways.

Business Loans Are Not Taxable Income

The most common types of small business loans—including term loans, lines of credit, and SBA loans—are generally not considered taxable income for federal income tax purposes.

The key thing to understand is that these loans are intended to be repaid over time. While the funds entering your business bank account may seem like revenue for accounting purposes, you have a legal obligation to pay this money back later. Therefore, the IRS does not view it as taxable income.

Some examples of business financing where the proceeds are not taxed include:

• Term loans from banks or online lenders
• Lines of credit that let you access funds as needed
• SBA 7(a) loans backed by the Small Business Administration
• Equipment financing loans for major purchases

As long as the loan is bona fide debt that you fully intend to repay, you do not have to claim the loan amount as income.

Exceptions: Forgiven and Discharged Loans

There are two scenarios where a business loan can suddenly become taxable income

1. If the lender forgives part or all of the remaining balance

2. If the loan is discharged due to bankruptcy.

In these cases, the IRS views the forgiven or discharged amount as essentially a cash gift to the business. You no longer have to repay it, so it becomes recognized as taxable income.

PPP Loans

A major exception to this rule was PPP loans during the COVID-19 pandemic. Congress allowed any forgiven PPP loan amounts specifically to be excluded from a business’s taxable income. But this provision only applied to PPP and not other loan types.

Barring similar exceptions, any amount of principal, interest, fees, or other loan balances forgiven by the lender or discharged through bankruptcy would generally become taxable income to the business in the year this occurs.

How Business Loans Can Impact Your Taxes

Taking out a loan may not generate immediate income taxes, but it can still influence your tax situation in a few key ways:

Interest Expenses Are Deductible

One way many small business owners reduce their tax bill is by deducting interest paid on loans used for business purposes.

When you make loan payments each month, part of that payment goes toward the interest owed and part pays down principal. The IRS allows you to deduct the interest portion from your taxable income as a normal business expense. This can provide substantial tax savings compared to making those payments with after-tax money.

To qualify for deduction, the loan must meet the following criteria:

• Bona fide debtor-creditor relationship
• Loan used for business needs and expenses
• Market rate of interest charged

As long as it passes these tests, the interest on small business loans—SBA, term, equipment, lines of credit, etc.—is typically deductible.

More Capital Can Lead to More Expenses

Taking out a sizable small business loan also gives you more capital to invest in deductible expenses:

• Salaries and benefits
• Office rent and utilities
• Equipment, hardware, and software
• Marketing and advertising
• Professional services like legal and accounting
• Licenses, dues, subscriptions, etc.

Spending loan proceeds on ordinary business expenses like these can further reduce your taxable income. Just be sure to keep detailed records separating personal and business spending.

Quarterly Estimated Taxes May Rise

If the influx of capital from a business loan leads to significantly higher income, you may need to increase your quarterly estimated tax payments to the IRS.

This is especially true if you have variable or seasonal revenue streams. Having a large loan disbursed in one quarter could push your estimated tax obligation for the year higher than normal.

Getting hit with penalties for underpaying estimated taxes can negate some of the benefits of relying on debt financing. Monitor your tax situation closely when taking on a substantial new loan.

How Different Business Structures Are Taxed

Your business structure also influences the tax implications of financing:

• Sole proprietorships: Reported on Schedule C along with your personal tax return. Interest is deductible and no special forms needed.

• Partnerships and LLCs: Pass-through entities where loan activity is reported on partners’ personal returns. Similar to sole proprietorships.

• S corporations: Passed through to shareholders’ personal returns. Interest may need to be separately stated.

• C corporations: File a corporate return. Tax situation more complex but interest still deductible.

Consult your accountant on the best way to handle loans based on your entity type.

Alternative Ways to Raise Business Capital

While they can provide an invaluable infusion of cash, loans are not the only way to fund your business. Some alternative capital-raising options include:

• Business credit cards: Quick access to revolving credit lines. Interest also deductible.

• Equity financing: Sell ownership shares rather than taking on debt. No repayment needed.

• Crowdfunding: Platforms like Kickstarter and Indiegogo for pooling small investments.

• Bootstrapping: Fund growth with cash flow rather than outside capital. Slow but debt-free.

• Grants and incentives: Federal or state programs to support targeted business activities. Don’t need to be repaid.

Each of these options has pros and cons to weigh against debt financing. A balanced and thoughtful capital strategy is key for any growing business.

The Bottom Line

Overall, small business loan proceeds themselves do not count as taxable income in most common scenarios. Just don’t rely on this as an indefinite interest-free loan from the government.

Work closely with your accountant or tax professional to report any business loans accurately, maximize helpful deductions, and avoid any nasty surprises when it comes time to file. With the right tax planning, financing can be a strategic move to drive growth and expansion in your company.