Depending on the type of financing you use to fund your business, the interest you pay may be tax deductible.
If there’s one word to describe the quality that helps small business owners succeed, it’s being resourceful. They have a vision for their business, and to finance it, they often max out their credit cards and incur other personal debt, all in the noble pursuit of turning their dreams into reality.
What you might not know about are the availability and advantages of another funding option: getting a small business loan. One key advantage of going this route is the savings you can realize at tax time when you add up the interest you’ve paid on a business loan and deduct it right off the amount you use to calculate what you owe the IRS.
Why is business loan interest deductible?
Simple reason—because it’s a legitimate business expense. The government doesn’t expect businesses to self-finance their ventures. It’s true of the big corporations, and it’s true of the little guy, too.
Keep in mind, the whole point of deductions on your business tax return is to identify expenses that played a role in your business development. As such, along with the other deductible expenses you’re familiar with—such as office equipment and supplies, advertising, business use of your vehicle, and fees you pay to your lawyers and other professionals—business loans (and even business credit cards) are fair game, because the IRS sees them simply as your chosen method of raising funds.
What’s the fine print?
Deducting business loan interest is allowable as long as the following are true:
- You spend the funding on business-related activities. It sounds obvious, but the IRS expects you to spend business funding on business expenses. Keep records of how you spend your loan distributions to make yourself audit-proof in case they ever ask.
- You borrow from an established lender. For interest to be deductible, your loan needs to come from a financial institution, not from family or friends—unless you keep careful records of the agreement by signing a promissory note with clear terms and track all of your repayments.
- You actually spend the money. The funds can’t just sit in your bank account—you need to show you applied them to a business expense.
- You don’t refinance the business loan. When you use a second loan to pay off the first one, the IRS doesn’t consider the payoff to be a business expense, and so your interest on the original loan isn’t deductible. Factor that in when you’re tempted to refi into a lower rate.
What kinds of loan products allow for interest deduction?
- Term loans are the most common business loan type. You get the funds up front in a single distribution, and you pay off the balance on a set schedule over a number of years.
- Short-term loans are like term loans, but you typically pay them off within the same tax year in which you receive the distribution. Be aware that most of these loans use a standard annual percentage rate (APR) to calculate interest, so work with your lender and your accountant as needed to clarify the amount you’ll be able to deduct. You can also choose a lender like QuickBooks Capital, where you can automatically track your interest deductions right in QuickBooks.
- Business credit cards and business lines of credit let you draw on a revolving account of available capital for expenses related to your business.
- Acquisition financing refers to a loan you take out for the specific purpose of buying another business. If this is in your plans, and you plan to continue running the business you acquire, then the IRS understands this as an extension of your business operations.
As with all tax-related matters, consult with your accountant to determine the best strategy for taking business loan deductions when you file. The result could be a real boost to your bottom line.