Great news for small business owners — the interest you pay on a loan can be tax-deductible if you meet the right criteria outlined by the IRS. Paying off loans can be a mental burden, so in order to lessen that burden, small business owners are able to deduct the interest as a business expense.
How Do You Qualify for a Loan Interest Tax Deduction?
Firstly, your loan must be secured from an official lender, such as a bank or other traditional financial institution. This may seem obvious, but often times businesses that are just getting started will take initial funding from friends or family. Even if those people are charging you for the loan, it is likely too informal for the IRS to accept any write-offs for this type of interest. The IRS wants to ensure small business owners have a clearly defined repayment schedule and are legally liable.
Additionally, the funds from a small business loan can’t just sit in your bank account. There needs to be proof that the money is actively being spent on business expenses, growth, marketing, hiring, etc. to be eligible for deduction. Even if you’re regularly paying off the principal and interest, the funds also need to be in use.
Types of Business Loans and How to Deduct Interest
Regardless of the type of loan you choose, it’s most likely that all or at least some of the interest can be deducted. How much interest you can deduct and when will depend on both the interest and repayment terms. The most common loan types are as follows:
- Term loans — Borrowers are given a lump sum of cash upfront that is repaid over an agreed-upon time period and within specified lending terms. You can often secure higher loan amounts and can make lower payments over a longer time period. Generally, interest on a term loan is deducted in the corresponding year that payments were made.
- Lines of credit — These function much like a credit card in which you are granted up to a certain credit limit and can access those funds at any time and in whatever amount. As you continually pay off the outstanding balance, the available credit replenishes. You are only required to pay interest on funds that have been withdrawn, and for that reason, the amount of interest you can deduct will depend on the usage of your available credit.
- Personal loans — While this is not technically a business loan, personal loans can sometimes be used for both personal and business purposes, such as a car loan used partially for business purposes or part of your mortgage being used for a home office. If you use your car 10% of the time for business operations, you can proportionally deduct 10% of the loan interest on your tax return.
Collaborate with Your Lender and Tax Accountant
To determine the specifics of the business loan you have, you can always speak with your lender to check the status of what you owe, how much you’ve paid in interest, and how much you can deduct. It’s also always a good idea to talk to your tax accountant or financial advisor for additional assistance and to help avoid any errors or inaccuracies.
At Republic Bank, we have a team of expert bankers and financial advisors dedicated to keeping you on the right track and helping your business grow with as few roadblocks as possible. Reach out to us today at 800-526-9127 or read through our resource library for more information!