If you’re considering taking out a small business loan to fund a big project or replace that failing piece of equipment, you may wonder how that increase in capital affects next year’s taxes.
The good news is that most loans won’t materially alter what you owe in taxes. Receiving a lump sum in your bank account from a lender isn’t the same as earning money for your business, so that principal amount won’t be taxed.
The primary way that your tax responsibilities will change is regarding the interest payments you make on your loan. Depending on the type of loan, as well as the legal structure of your business, you generally can deduct your interest payments and lower your tax burden.
Taking on a business loan will always carry risk, but the ability to write off your interest payments as business expenses should make the added cost a bit more palatable.
Is The Interest On My Business Loan Tax Deductible?
Yes, for the most part, you can write off your business loan interest payments as a business expense. There are some qualifications your loan must meet, essentially, your loan must be a legitimate loan from a legitimate lender. You cannot borrow money from friends that you may or may not fully repay and deduct your interest payments to them.
Additionally, you have to actually spend the funds you’ve received on your business. If your loan just sits in your bank account, that’s considered an investment, not an expense—even if you’re making payments on the loan principal and its interest.
When Is My Interest Not Tax Deductible?
There are certain exceptions to the rule that your business loan interest payments are tax deductible.
- When you refinance your business loan: You can’t deduct interest you pay with funds borrowed from the original lender through a second loan. Once you start making payments on the new loan, those interest payments are deductible.
- Fees incurred to have funds on standby: If you have funds available on a standby basis and your lender charges you a fee to keep them available, you cannot deduct them as interest payments.
What Types Of Business Loans Have Tax-Deductible Interest Payments?
With exceptions that relate to your specific loan and how you’re using it, nearly every kind of small business loan will have interest payments that you can deduct. Let’s review how that would work for the most common types of business loans:
Lines Of Credit
A business line of credit is typically a revolving form of credit, allowing you to draw on a pool of pre-approved funds from your lender—similar to a credit card, but typically with much higher funding limits. You draw your funds, repay the draw on a schedule, and can draw again as needed.
Because you only pay interest on what you withdraw, your interest payment deductions will depend on how you use your LOC.
Short-term loans are similar to regular term loans, with one obvious difference: They have shorter repayment periods, oftentimes lasting less than a year. Therefore, you may deduct all the interest paid within the same financial year.
Loans For Buying Existing Businesses
If you want to buy another business with the goal of actively running it, you might take out a loan to help you do so, and interest payments on that loan will be deductible.
If you want to buy another business but don’t expect to actively run it, that’s considered an investment, not a business expense. You may or may not be able to deduct interest on that loan, so speak to your accountant to see what your specific situation calls for.
Taking on a small business loan should always be a net gain for your business—a means to achieve better results in the long run. That being said, there is certainly an upfront cost to them, and interest payments are the clearest example of that cost.
The fact that you can write those costs off as tax deductible is a huge benefit to small business owners, so make sure to discuss the tax ramifications with whatever product select with your accountant and team to make sure you are maximizing your tax savings.