Running your small business isn’t cheap. And securing financing to run your business isn’t cheap, either. Taking out business loans can weigh you down with high interest rates. To help offset this expense, you might be able to claim a business loan interest tax deduction.
Not all interest expenses are tax deductible. To claim this deduction, you have to qualify. Are you eligible for the business interest expense write off?
What is the business loan interest tax deduction?
When you take out business loans, your lender charges interest, which is a percentage of the original loan, or principal. You are responsible for paying the interest in addition to the principal. The IRS business loan interest deduction lets you write off the annual interest you paid on a business loan.
With the business loan interest tax deduction, you can deduct the amount you paid in business loan interest from your tax liability. This deduction reduces the amount you owe in taxes.
Is interest expense tax deductible all the time? No. The IRS has rules on claiming the business interest deduction on your tax return.
Can your business claim the interest expense deduction?
You can only claim the interest tax deduction if your loans are for business purposes, like purchasing business assets or paying business expenses. Qualifying business loans include term loans and lines of credit.
According to IRS Publication 535, you can only deduct business loan interest if you meet all three of the following requirements:
- You are legally liable for the debt
- You and the lender intend that the debt be repaid
- You and the lender have a true debtor-creditor relationship
To comply with the above three requirements, keep your loan agreement in your records, make regular payments, and verify your lender processes payments.
Do not try to claim the deduction for interest on loans used for personal expenses. If you have a loan that covers both business and personal expenses, you can deduct the portion of interest paid for business expenses.
You cannot claim the interest deduction if you pay interest on loans you aren’t using (e.g., the amount is sitting in your business bank account).
If you refinance a loan and use the new loan to pay interest on the old loan, you cannot claim the interest tax deduction.
Interest on overdue business taxes does not count as a qualifying interest tax deduction. If you are paying interest on overdue business taxes, you cannot claim the deduction.
If you prepay interest, you can only deduct the amount that applies to the current tax year.
Limits to the business loan interest tax deduction
The 2017 Tax Cuts and Jobs Act reduced the amount of business loan interest some businesses can deduct. Because of the law, large businesses can deduct 30% of their adjusted taxable income for net business interest.
This deduction reduction does not apply to small businesses with average annual gross receipts of $25 million or less over a three-year lookback period.
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How to claim the interest expense deduction for your business
Claim the business loan interest tax deduction on your small business tax return. The form you use depends on your business structure.
If you are structured as a sole proprietorship or single-member LLC, enter your business interest expenses on Schedule C, Profit or Loss From Business (Sole Proprietorship).
Owners of partnerships and multi-member LLCs must use Form 1065, U.S. Return of Partnership Income, to report interest expenses.
If you have a corporation, write off your business loan interest tax using Form 1120, U.S. Corporation Income Tax Return. S Corp owners must use Form 1120-S, U.S. Income Tax Return for an S Corporation.
How to make an accurate interest tax deduction claim
Make sure you claim the correct amount of interest paid on your tax return. Statements from your lender should show how much interest you paid during the year.
You should also record interest expenses in the Interest Expense account in your accounting books. That way, you can refer to your small business general ledger to determine how much you paid in interest throughout the year.
It’s important that you reconcile your Interest Expense account with your interest paid statement to verify your records are accurate. Then, report the interest expense on your tax return.
Let’s say your lender charges you simple interest at 8% on a $50,000 business loan taken out for a three-year period.
Use the following simple interest formula to calculate your interest liability:
Simple Interest = Principal X Interest Rate X Number of Years
Simple Interest = $50,000 X 0.08 X 3
Simple Interest = $12,000
In total, you owe $12,000 in loan interest. Your annual interest liability is $4,000. If you are a small business that uses the loan for business purposes, you can claim a $4,000 interest deduction on your business tax return.
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This article is updated from its original publication date of September 20, 2018.This is not intended as legal advice; for more information, please click here.