If you’ve taken out a loan to start or build your business (or you’re thinking about doing so), the interest you pay on that loan will likely be tax-deductible as a business expense.
This includes interest charged on all types of loans, including term loans, short-term loans, lines of credit, mortgages on business real estate, and even personal loans, provided the funds are used for business purposes.
There are a few caveats, however. To be eligible, you’ll need to meet some criteria as defined by the Internal Revenue Service (IRS). Here’s everything you need to know to write off loan interest as a business expense.
Deducting Business Interest: The Short Answer
If you’ve been wondering whether or not business loan interest is tax-deductible, the short answer is — yes. If the loan is being used for business purposes, you can likely deduct 100% of the interest you pay to the lender.
Recommended: Comparing Personal Loans vs Business Loans
Deducting Business Interest: The Long Answer
While business loan interest is tax-deductible, there are some requirements that a loan has to meet first.
Who you take the loan out from, what you spend the money on, when you spend it, and how your business is structured all factor in when determining whether or not you can get a tax break on that interest, as well as how much of the interest you can deduct.
It’s important to know the IRS guidelines and follow them if you are doing your own tax filing or have a trusted accountant who can assist you.
Who Qualifies for a Business Interest Tax Deduction
The IRS has some criteria for allowing you to get a tax deduction on your business loan interest, which include:
• You must be legally liable for the debt. That means that you (through your business) and no other party are responsible for paying back the loan.
• Both you and the lender intend the debt to be repaid. It needs to be a true small business loan (not a gift of cash) with repayment terms that you have agreed to and are spelled out in a legal document.
• You and the lender must have a true debtor-creditor relationship. If you borrow money from a relative or friend and use it for business purposes, it can be very tricky to deduct any interest you pay them. To do so, the loan needs to be set up like any other business loan. That means signing a promissory note, paying a reasonable interest rate, following a repayment schedule, and keeping records of every transaction.
When Is It Deductible?
The interest on a business loan is only deductible if you actually spend the money for legitimate business expenses. If you take out a loan and the funds sit in your account, you can’t deduct any of the interest, even if you’re paying off the principal and interest of your loan every month.
Money that is left in the bank and goes unspent is considered an investment and not an expense, which is why that interest isn’t tax-deductible.
And keep in mind: What you spend the loan proceeds on has to be for your business. You can’t use a business loan to put in a new pool at your house or cover other personal expenses and then deduct the interest.
The key is to categorize expenses for your business so you can easily see where you spent the loan proceeds and can prove, if asked by the IRS, that you spent the funds on business-related expenses.
When Isn’t It Deductible?
There are some situations in which your loan interest is not tax-deductible. You typically cannot deduct:
• Interest on a personal loan if it’s used for personal expenses or to pay debts your business doesn’t owe
• Interest that is being paid by a second loan (though interest payments on the second loan are tax-deductible)
• Any fines or penalties paid to your lender
• Interest that must be capitalized, which is interest added to the principal balance of a loan or mortgage (this interest expense needs to be depreciated along with the other costs of the asset)
• Interest on overdue taxes (unless you are a C-corporation)
Different Deductions for Different Loans
Here’s a look at how tax deductions apply to different types of small business loans.
Term Loans
If you have a term loan, the interest can generally be deducted in the corresponding year that payments were made. This means if you take out a term loan with a three-year repayment period, you will deduct the interest paid in each of three consecutive tax years, with the amount deducted reflecting the amount you paid in interest each year.
You should get a notification from your lender on how much you have paid in interest for the year. You can also find this information on your amortization schedule.
Short-Term Loans
Short-term business loans have much shorter repayment periods than traditional term loans, typically three months to a year. Even in this short period, though, you pay interest.
Some short-term loans use a factor rate rather than annual percentage rate, since the repayment period may not be an entire year. Either way, you can typically write off the interest or fee you pay on the loan.
Business LOC
With a business line of credit, you don’t get a lump sum of cash like you do with a loan. Instead, a line of credit (LOC) gives you access to cash up to a pre-approved maximum. You can take out however much you need up to the limit, repay it, and then borrow it again.
To deduct interest on a line of credit, you must look at the statements on your business LOC account to see how much you borrowed in a given year and how much of what you paid back was interest.
Personal Loans
Personal loans generally can’t be used for business expenses, but if your lender allows it, the interest on the loan would then be tax-deductible. If you use part of the funds for business expenses and part for personal expenses, however, it could get complicated. You would need to separate out the interest paid on the portion that went toward business expenses, since only that portion of the interest can be deducted for the year.
Merchant Cash Advances
A merchant cash advance is not technically a loan, but an advance on future sales. Because you don’t pay interest on a merchant cash advance, you don’t have any interest that you can write off.
Business Acquisition Loans
If you take out a loan to purchase another business, the interest you pay may or may not be tax-deductible. If you plan to operate the business, the loan interest will likely be tax-deductible.
If you don’t plan to be involved in operations, however, the IRS sees this as an investment, and the tax rules are more complicated. In this scenario, it can be a good idea to consult a tax professional to determine whether or not this interest is tax-deductible.
Debt Refinancing Loans
Refinancing a business loan can be a smart idea if it allows you to pay a lower interest rate on your balance. Just know that when you use one loan to pay off another, you can’t deduct the interest you’re paying off with the second loan. Once you start paying interest on the second loan, however, you can typically deduct those interest payments.
Non-Profit Loans
Not-for-profit organizations are exempt from federal income taxes, so interest paid on non-profit business loans, which are geared specifically for businesses that have a 501(c)(3) status, would not need to be deducted.
Is There Any Reason Not to Deduct Business Loan Interest From Taxes?
No. Deducting what you pay in loan interest allows you to reduce your business’s taxable income, which, in turn, means your company will owe less in taxes. The result: Higher profits.
There are limits, however, on how much interest you can deduct in any given year. You can’t deduct more than 30% of your adjusted taxable income, for example. There are some other limits imposed by the IRS, but they generally don’t apply to small businesses. Your accountant can tell you if any other caps are applicable to your situation.
Other Deductions to Keep in Mind
Business loan interest is just one of many business expenses you can deduct on your taxes. Here are some other deductions you may be able to take.
Office Supplies
You can typically deduct every pen, printer cartridge, and office supply you buy for your business. For an item to be deductible, it generally needs to be considered essential to running a functional office.
Travel Expenses
If you travel for business, whether that’s to visit a client across the country or attend a trade show, these costs can be tax deductions. This includes airfare, rental cars, gas, tolls, hotels, and meals.
Vehicle Expenses
If you use one or more vehicles for your business, whether that’s for delivering products or visiting clients, all expenses related to the vehicle can be tax deductions as long as you keep track of the mileage.
Meal Expenses
If you take clients (or potential clients) out for a meal to discuss business, these costs may be 50% tax-deductible. In order to be eligible, food costs typically need to be reasonable — extravagant meals likely won’t qualify.
Payroll Tax and Employee Benefits
As long as they’re not for you or other business partners, employee salaries and benefits are generally considered write-offs for small businesses. This category typically includes employee wages, paid time off, commissions, and bonuses, as well as employer-sponsored life insurance or retirement account contributions.
Home Office
If you run your business out of your home, you may be able to deduct expenses related to creating and maintaining that workspace. To qualify for the home office deduction, you generally need to utilize part of your home regularly and exclusively for business.
Rent
If you pay rent for an office, warehouse, retail space, or other type of business property, that monthly rent expense may be fully tax-deductible. Keep in mind that if you deduct rent as a business expense, you will not likely be able to take the home office deduction, as well.
The Takeaway
If a loan is being used for business purposes, then the interest you pay to the lender is typically tax-deductible. There are a few requirements, however: You must be legally liable for the debt, you and the lender need to have a true lender-debtor relationship, and the funds from the loan need to be spent on your business during that tax year (not sitting in the bank).
There are some situations that can be a little trickier than others, so it can be a good idea to consult an accountant who fully understands tax law, as well as the details of your business and finances.
If you’re interested in getting a loan to grow your business — while also getting some tax relief — there are many different types of loans you can consider.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How much interest can you write off on a business loan?
You can write off the interest you paid on a loan during a given year, up to 30% of your adjusted taxable income. There are some other limits imposed by the IRS, but they generally don’t apply to small businesses.
Is a small business loan taxable?
You won’t be taxed on the funds you receive on a business loan because you will pay this money back. However, the interest you pay on the loan may be tax-deductible.
How do I report interest paid on a business loan?
Where you report interest depends on what business structure you have. For sole proprietors and single-member LLCs, you’ll report it on Schedule C of Form 1040. For partnerships and multi-member LLCs, you will report it on Form 1065. For corporations, you’ll need to report it on Form 1120 or 1120-S.
Do business loans count as income?
No, the IRS does not consider business loans income because they are repaid. Therefore, loan proceeds are not taxed.
Photo credit: iStock/Pekic
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