You might be curious about how the sudden infusion of cash will affect your taxes for the following year if you’re thinking about getting a small business loan to finance a significant project or replace that worn-out piece of equipment.
The good news is that most loans won’t significantly affect how much tax you owe. Since getting a lump sum from a lender into your bank account isn’t the same as making money for your company, the principle won’t be taxed.
Your loan’s interest payments will be the main factor affecting how your tax obligations change. You typically are able to deduct your interest payments and lessen your tax burden depending on the type of loan and the legal structure of your business.
Risks associated with taking out a business loan will always exist, but being able to deduct your interest payments as business expenses should help to make the additional cost more tolerable.
Is The Interest On My Business Loan Tax Deductible?
Yes, for the most part, you can write off your business loan interest payments as a business expense. There are some qualifications your loan must meet, however, according to the IRS:
Your loan must essentially be a legitimate loan from a legitimate lender. You are not permitted to borrow money from friends, which you might or might not fully repay, and subtract interest payments from that loan.
Of course, this doesn’t mean you can’t borrow cash from friends or family if you want to; just be aware that they aren’t regarded as “real” lenders like banks or online lenders, so you won’t be able to deduct your interest payments from your income. This is due to the IRS’s inability to determine whether these informal agreements are merely a means for you to avoid paying taxes.
Additionally, you need to invest the money you’ve received in your company. Even if you are making payments on the loan principal and interest, if your loan is simply sitting in your bank account, it is regarded as an investment rather than an expense.
When Is My Interest Not Tax Deductible?
The general rule that your business loan interest payments are tax deductible has some exceptions.
What Types Of Business Loans Have Tax-Deductible Interest Payments?
Almost all types of small business loans have interest payments that you can deduct, with some exceptions that are specific to your loan and how you’re using it. Let’s go over how that would function for the most typical business loan types:
Term Loans
A term loan is a one-time deposit of money into your bank account that you must repay over a period of months or years according to a predetermined schedule and an agreed-upon interest rate.
When you agree to a term loan, you will have a loan amortization schedule so you understand how much of each loan repayment is principle and how much is interest. Typically, term loans will be structured so you pay more interest towards the beginning of your repayment schedule, which means larger interest deductions are possible upfront.
However, since you will probably have to pay interest every year that you repay your loan, be ready to set aside money for loan repayments until you are debt-free.
SBA loans, which are term loans partially guaranteed by the Small Business Administration, function much the same way—and you can deduct your interest payments accordingly.
Lines Of Credit
Similar to a credit card, a business line of credit typically has much higher funding limits and is a revolving form of credit that lets you access a pool of pre-approved funds from your lender. You can withdraw money as needed, repay it according to a schedule.
Your interest payment deductions will depend on how you use your LOC because you only pay interest on what you withdraw. Before filing your taxes, verify with your lender what you pulled.
Short-Term Loans
With one obvious exception, short-term loans are similar to traditional term loans but have shorter repayment terms—often less than a year. Consequently, you can write off all of your interest payments in a single annual tax return.
Additionally, some short-term loans determine interest payments using a factor rate rather than an APR. Once more, speak with your lender to determine your exact interest rate so that you will know what you can write off when tax time comes.
Personal Loans
You can use a personal loan to finance your business, and occasionally people choose to do so to avoid having lenders review their business credit histories.
Your interest payments are deductable if you fully fund your business with a personal loan. You can only deduct some of the interest if the loan is being used for a variety of things. You can deduct a portion of the loan on your business taxes if you use a personal loan to buy a car that you occasionally use for work.
Loans For Buying Existing Businesses
You might take out a loan to assist you in doing so if you want to buy another business with the intention of running it actively. The interest payments on that loan will be deductible.
If you want to purchase a different company but don’t intend to run it yourself, that is regarded as an investment rather than a cost of doing business. Consult your accountant to determine whether you can or cannot deduct interest on that loan given your particular circumstances.
Merchant Cash Advances
MCAs, in which a lender lends you money in return for a percentage of daily credit card sales until you pay the debt back, can have very high APRs and are frequently best reserved as a last resort Additionally, their “fees” are actually purchases of your future receivables rather than interest payments, so As a result, the majority of CPAs cannot or will not deduct your payments from your return. Avoid this option if you can because you are paying interest while receiving none of the tax benefits of actual interest.
A small business loan should always benefit your company, serving as a means of achieving long-term improvement. However, there is undoubtedly a one-time expense associated with them, and the best illustration of this expense is the interest payments.
Small business owners benefit greatly from being able to deduct those expenses from their taxes, so be sure to discuss the tax implications of any product you choose with your accountant and team to ensure you are getting the most tax savings possible.
FAQ
What type of loans are tax deductible?
Debt expenses that can be written off even though personal loans are not tax deductible Mortgage, student, and business loan interest is frequently deductible on your yearly taxes, effectively lowering your taxable income for the year.
Is a loan payment a business expense?
The majority of the time, interest paid on business loans is a currently deductible business expense. It doesn’t matter if you pay interest on a bank loan, a personal loan, a credit card, a line of credit, a car loan, or a mortgage on real estate used for business purposes.
Can you loan your LLC money and charge interest?
Yes. The only drawback is that you’ll need to prepare the necessary paperwork to acknowledge the debt the company owes you and the terms of its loan repayment. In order to make the transaction legal, your LLC must also make consistent payments, and you must charge at least a minimal interest rate.