Is a Business Loan Considered Income? Everything You Need to Know

Obtaining financing is often a crucial step for entrepreneurs looking to start or grow a business. Business loans provide necessary capital to fund operations, equipment purchases, hiring, marketing and other expenses. But business owners may wonder, is the money you receive from a business loan considered taxable income?

The short answer is no—with a few exceptions—business loan proceeds are not treated as income. However, interest paid on a loan may be tax deductible, and expenses funded by the loan could potentially be written off. Let’s take a closer look at how business loans impact taxes.

Business Loan Proceeds Are Not Taxable

The IRS does not consider borrowed money to be income. This is because a business loan is essentially a liability—funds that must be paid back. While the loan provides operating capital upfront, the borrowed amount is not yours to keep.

For example, if your business gets approved for a $100,000 small business term loan, that $100,000 is not considered part of your business’s gross income. You don’t have to pay income tax on the loan funds themselves.

The same concept generally applies to other types of financing like lines of credit, SBA 7(a) loans, equipment loans and merchant cash advances The proceeds themselves are not subject to income tax.

Exceptions: Debt Forgiveness and Cancelled Debts

There are two scenarios in which a business loan could trigger tax liability

• Debt forgiveness: If the lender forgives all or part of your loan balance, the forgiven amount is treated as taxable income. For example, if your business takes out a $50,000 loan and the lender later cancels $20,000 of it, that $20,000 in debt forgiveness becomes taxable income.

• Cancelled debt: If you settle a loan obligation for less than the full balance owed, the difference is considered cancelled debt income. For instance, if you owe $30,000 on a loan and negotiate to pay just $20,000 to settle it, the $10,000 difference counts as taxable cancelled debt.

However, this rule does not apply to Paycheck Protection Program (PPP) loans that were forgiven under the CARES Act relief programs. PPP loan forgiveness does not create taxable income.

Interest Expenses May Be Tax Deductible

Although loan proceeds themselves are not income, interest paid on a business loan is often tax deductible.

Deducting interest expenses reduces your taxable income, which in turn lowers your overall tax bill. To qualify for the deduction, the following criteria must be met:

• You have a true creditor-debtor relationship with the lender.
• You have documentation showing the loan obligation and repayment.
• Loan funds were used for legitimate business expenses.
• Your business is the legal entity responsible for the loan.

If you meet these requirements, the interest portion of your loan payments would count as a business expense.

For example, let’s say your business makes monthly payments of $1,500 on a term loan. Of that, $200 goes toward interest and $1,300 pays down principal. You could claim the $200 interest amount each month as a tax deduction.

Expenses Funded by the Loan May Be Deductible

In addition to deducting interest, expenses paid for with the loan proceeds may also be tax deductible:

• Startup costs: Initial expenses like license fees, company registration and website development can be deducted.

• Equipment: Purchasing equipment like machinery, vehicles or computers can be expensed.

• Supplies: Office supplies, inventory and materials can potentially be deducted.

• Rent: Commercial lease payments for retail space, warehouses or office rent are deductible business expenses.

• Salaries: Employee payroll, commissions and contractor payments can be written off.

• Utilities: Electricity, phone, internet and other utility fees can be deducted.

• Marketing: Advertising, content development and social media expenses are deductible.

• Travel: Business-related travel like client meetings, conferences and events may qualify.

Keeping detailed records is key when claiming deductions for expenses paid with loan proceeds. You’ll need to prove the expenses were ordinary and necessary costs of operating your business.

How to Handle Business Loan Tax Reporting

How you report business loan details and related deductions depends on your entity structure:

Sole Proprietorships and Single-Member LLCs

For sole proprietors and single member LLCs, business income and deductions are reported on Schedule C and filed with your personal 1040 tax return. The loan itself is not reported. But you would claim any applicable interest, expenses or depreciation deductions on Schedule C.

Partnerships and Multi-Member LLCs

Partnerships and multi-member LLCs treated as partnerships file an informational Form 1065 return. Individual partners then report their share of income and deductions on Schedule K-1 with their personal returns.

S Corporations

S corps file Form 1120-S to report business income, deductions and other details. Shareholders get a Schedule K-1 to file with their personal returns reflecting their proportional share.

C Corporations

C corps file Form 1120 to report all corporate income, gains, losses and deductions. Business loan details are reported directly on the 1120.

Strategies to Reduce Tax Liability on Business Loans

If your business relies on financing, here are some potential ways to minimize tax obligations:

• Inquire about tax deductible interest rates when comparing loan options. Higher interest results in larger deductions.

• Consider using loan proceeds for startup costs that can be fully deducted in the first year.

• Buy equipment or assets eligible for accelerated depreciation deductions.

• Time large purchases of supplies and inventory at year end to maximize deductions for that tax year.

• Pay annual expenses like insurance premiums, software subscriptions and association dues in advance to accelerate write-offs.

• Contribute the max amount to retirement accounts like Solo 401(k)s and SEP IRAs to reduce self-employment tax liability.

Key Takeaways on Business Loans and Taxes

• Business loan proceeds are generally not considered taxable income, except for cancelled or forgiven debts.

• Interest expenses on business loans are often tax deductible, subject to certain criteria.

• Expenses paid for with loan funds may potentially qualify as deductible business expenses.

• How loans are reported and deductions are claimed depends on your business structure.

• Tax planning strategies can help minimize liabilities when financing is involved.

Thoroughly documenting expenditures and consulting a tax professional can help ensure you maximize available deductions for your business loans and related costs. With the right tax preparation, financing can provide long-term value that outweighs the tax implications.

Frequency of Entities

www.lanterncredit.com – 3
www.bankrate.com – 2
business loan – 21
income – 18
tax/taxes – 24
deduct/deduction – 11
interest – 10
expense/expenses – 9
loan proceeds – 5
debt forgiveness – 3
cancelled debt – 2