Business Interest Tax Deduction: How to Write Off Business Loan Interest On Your Taxes
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Debt. It’s a word that can create a sinking feeling in the pit of your stomach. Whether you’re dealing with small business loans, or you’re trying to pay down personal debt, it might feel like an uphill battle. It can come as a welcome relief to know that the interest on some of your loans is tax deductible. Unfortunately, not all loan interest qualifies. Knowing what you can deduct (and what you can’t) can help you reduce the financial impact that your business loans can have.
How to write off business loan interest
Are you feeling weighed down by your business loans? In some cases, you’re able to write off the interest on your business loans when you file your taxes each year. As a business owner, you can deduct the interest for bank loans, business credit cards, online loans and lines of credit.
The reason you can deduct business loan interest is because it is, technically, a business expense, according to the IRS. Because the principal balance of your loan (or other line of credit) is the actual balance you’re financing, any interest incurred on the debt is an added expense that your business needs to pay. So, how do you go about deducting your business loan interest?
When filing your taxes, you’ll fill out an IRS Schedule C form to list your loan’s deductible interest. The full amount of your business loan interest is deductible. So, if you have a loan for $10,000 with an annual interest rate of 4.5%, you’re permitted to deduct the full 4.5% on your taxes. Keep in mind, you can still write off the interest if you used personal funds to secure your loan – which can be helpful for small business owners who are just starting to fund their business.
Finally, it’s important to know that you don’t just get to write off current business loan interest. If your business has run at a loss, you can get a refund of taxes paid in previous years. The Net Operating Loss (NOL) rule has been adjusted in recent years and you can now decide to carry the loss back to a prior year, or carry forward to a future year.
How to write off business car loan interest
Do you use a vehicle for your business? If so, you can deduct the interest on your business car loan. The fact is that the vast majority of business owners use a vehicle for their work in some capacity. However, many of them misunderstand the vehicle tax deduction if they are self-employed. Here’s what you need to know about deducting the interest on your car loan:
- You must only deduct the portion of the vehicle’s use that’s directly related to your business. If you use the vehicle for both personal and business driving, break it down by what percentage you use the vehicle for different purposes. Then, use that percentage to calculate how much of your interest is deductible. You have to be very technical about this and divide the vehicle’s use by total miles driven for both personal and business trips to reach your final percentage.
- You can also deduct the vehicle maintenance costs (or a percentage of the vehicle maintenance costs if you’re using the vehicle for both personal and business use). “This is something that many small business owners get wrong,” said Anthony Baldassano, CPA/PFS, and founder of Anthony & Associates Certified Public Accountants, LLC. “You have to take the actual expenses and multiply them by the percentage that the automobile is being used for the business.”
Also, don’t forget to keep your records. Operating expenses only count as a deduction if you have clear records of the vehicle’s use and the expenses you’ve incurred.
How to write off interest from a business purchase
You can also write off interest that you incur when purchasing a business. Unfortunately, this tax deduction is a little bit less cut-and-dry than business or car loan interest. When you borrow money to fund the purchase of another business, or even a small percentage of another business, the interest accrued on that loan can technically be deducted.
However, in some cases, this loan may be viewed as a capital expense. Capital expenses are considered assets of your business. That means they fall under the umbrella of startup costs, or an investment expense, which could potentially make interest not tax deductible.
- The three typical expenses you “capitalize” rather than deduct are:
Business start-up costs
- The three typical expenses you “capitalize” rather than deduct are:
- Business assets
There are some business start-up costs that can be deducted or written off, however. Your best bet in this situation is to speak with an accountant to ensure you’re maximizing your tax interests throughout the business purchasing process.
How to write off interest from family loans
In some cases, businesses are funded by loans that come directly from a close friend or family member. This is especially true among small business owners who can seek out lower interest rates from traditional lenders or are unable to get the funding they need with a suitable repayment schedule.
While a family loan may seem like a great idea for both parties, it has its drawbacks. The loan, while legitimate, may not be as carefully documented as an official business loan through a lender would be. Because many small business owners borrow from family in order to capitalize on a flexible repayment schedule, the interest the loan has accrued may not be closely tracked. Your family member may be investing in your business in good faith, assuming that you’ll pay them back in full plus interest whenever you’re able. Unfortunately, this isn’t an ideal situation for deducting the interest of this business loan on your taxes.
The IRS is nothing if not information-driven. It likes to see formal documentation of everything you plan to file each tax season. If you can’t prove it, you’ll be unable to take the deduction. That’s not to say that you shouldn’t take advantage of family loans if they’re in everyone’s best interest. Instead, focus on how to legitimize them in every way possible. Document the loan payments (including accruing interest) carefully and have all parties sign off on the agreement.
Also, don’t assume it makes more sense to take out a family loan without interest. The IRS could penalize you for taking out a loan with family and not paying its Applicable Federal Rates (AFR). Speaking with an attorney about the best way to legally set up the loan is going to save you a lot of headaches in the future, especially during tax-filing season.
Interest that you can’t write off
You can only write off interest that’s associated with “ordinary and necessary” business expenses. This means you can’t deduct interest on the personal loan you used to pay for a family vacation, or money that you borrowed to cover an expense that’s both personal and business-related (like an auto loan when the vehicle is used for both personal and business travel).
The bottom line
Writing off interest on your different business loans can help to save your small business a significant amount of money in the long run. However, if you do it incorrectly, you run the risk of undergoing a tax audit, owing the IRS money or being penalized. When in doubt, speak to an accountant to help guide your tax deductions and to make sure you’re saving as much money for your small business as possible.