It costs money to run a business. Thankfully, the tax code works in favor of small businesses in the form of tax deductions. From the overheads involved in running a home office to the expenses incurred on the road, there are numerous tax benefits designed to offset the cost of doing business. However, many of these deductions are overlooked or poorly understood, especially by new business owners.
For example, along with the home office deduction, the cost of healthcare premiums, and other substantial deductions, did you know that you can deduct the interest paid on any financial debts related to your business? This includes the interest on loans, credit cards (for interest on business purchases), and even money borrowed from friends or family (although the IRS will expect a lot of transactional documentation to back up this claim).
Here’s what you need to know about deducting the cost of small business debt, plus some limitations that you’ll need to be aware of.
What Your Small Business Can Deduct
The IRS guidance on what you can deduct is pretty straightforward:
You can deduct interest on any debts related to your business, including loans, mortgages, lines of credit, and credit cards if you meet all of the following requirements:
- You are legally liable for that debt.
- Both you and the lender intend that the debt be repaid.
- You and the lender have a true debtor-creditor relationship.
What You Can’t Deduct
Seems straightforward enough? For the most part, yes, but there are some complicated exceptions. The IRS delves into the nitty gritty of these in Publication 535. In summary, here’s a breakdown of key business debts that you can’t deduct the interest on:
- Loans used for personal purposes.
- Capitalized interest. Read more from the IRS.
- Interest paid with funds from the original borrower – Meaning you can’t deduct any interest on a loan if you take out a second loan with the original lender to cover the interest on your first. However, once you start making payments on the second loan, you can deduct the interest.
- Income tax interest – No, sorry! Any interest assessed on your individual income tax return is not a business deduction (unless you’re a C corporation).
- Tax penalties – Most penalties, such as fees for underpaying estimated taxes, are not deductible.
- Commitment fees or standby charges – Any fees incurred to have business funds available on a standby basis, are not deductible as interest payments.
- Loans borrowed from life insurance policies (over $50,000) on an employee or 20% owner.
There are a few other interest costs that aren’t deductible, for example, in the construction industry the interest on construction loans doesn’t qualify for the deduction, check in with your accountant or tax preparer if you’re not sure.
Purchased a Business? The Interest Might Be Treated Differently
If you borrow money to buy an S corporation, partnership, or LLC, it’s a good idea to get an accountant’s help in order to figure out how to deduct the interest on your loan. Each of these businesses is structured as a pass-through entity for tax purposes and the interest is allocated among the business’ assets.
Mingling Business and Personal Credit Can Get Problematic
As mentioned earlier, you can’t deduct the interest you paid on personal loans. If a loan is part business and part personal, you must divide the interest between the personal part and the business part. For example, if you’re paying interest on a credit card that you use for both business and personal use or if you’re hoping to deduct the interest on a car loan for a vehicle that’s used for both personal and business travel, you’ll need to calculate the percentage used for business expenses only.
If you‘ve been looking for a good reason to separate business and personal finances and keep excellent records, you’ve found it.
Filing your Business Debt Tax Deduction
To file your deduction, obtain any necessary records (IRS Form 1098) from your bank or lender totaling the amount of interest you’ve paid during the tax year. If you have several loans, calculate the total interest across each of these (and eliminate any personal expenses). Depending on your business structure you’ll show your expenses on the following IRS forms:
- Sole Proprietors/Single-member LLCs – Use the “Expenses” section of Schedule C
- Partnerships/Multi-member LLCs – Use the “Deductions” section of Form 1065.
- Corporations – Use the “Deductions” section of Form 1120.
For other information about which tax deductions your business might be eligible for, spend a few minutes with this Tax and Credits tool from Business.USA.gov. This earlier Fundbox blog also offers tips on everyday expenses that you can deduct.
About the Author:
Fundbox is a technology company disrupting the small business payments market. Fundbox is helping SMBs, freelancers and home offices grow by managing their cash flow better and by overcoming short term cash flow gaps.