Is Business Loan Interest
Tax-Deductible?

Cashflow is the lifeblood of any business. Commercial loans can help you maintain a good cash flow, and they offer an additional benefit as well: the interest charged on business loans is tax-deductible. However, there is a caveat: not all interest is tax-deductible, and not all loans qualify. In some cases, you may deduct a portion of the interest paid on your business loan. In other situations, it may be considered a gift and not deductible.

Ultimately, the deductibility of business loan interest depends on which type of business loan you take out for your organization and how you use the funds. Read on to learn about business loan interest and tax deductions so you can create your business plan accordingly.

Qualifications for Deducting Business Loan Interest

There are three major qualifications for deducting business loan interest, according to the Internal Revenue Service (IRS):

You or your entity must be legally liable for the debt.
You and your business lender must both agree that the debt will be repaid.
You and your business lender have a true creditor-debtor relationship.

There is a fourth qualification that is not explicitly laid out in the IRS’s materials but is necessary for you to be able to deduct any interest paid on any small business loan: you must spend the funds you acquire. In other words, you cannot take a loan and then let the funds sit in your business checking account, accruing interest on their own. This is then defined as an investment rather than a business expense.

When Business Loan Interest Isn’t Tax-Deductible

Letting your loan funds languish in a business checking account isn’t the only time interest isn’t tax-deductible. There are several other scenarios in which you can’t deduct business loan interest:

If you refinance your original business loan: Once you begin making payments on the new loan, you can deduct the interest from those payments. However, you cannot deduct any interest paid on the original loan through the new one.
If you racked up real estate points or loan origination fees: You can take out a business loan to buy property for your business, but the points or origination fees on the loan must be added to the value of the property. They will then be deducted over time via asset depreciation.
If it’s interest capitalization: This is when interest is added to the cost of a self-constructed long-term asset. These assets can include real estate or production facilities. Essentially, interest capitalization turns the funds into an investment, which negates their deductibility.
If you incur fees for funds on standby: If you keep any funds from a loan on standby, and your lender charges fees for keeping them available to you, those payments are not tax-deductible.

Since you’re not able to deduct business loan interest from your taxes in those scenarios, it’s important to understand the extent of your business’s tax liability before taking out a loan.

Deducting Business Loan Interest From Taxes

Despite these restrictions, there are situations in which your loan interest can be deducted:

Term Loans

Term loans are the traditional loans you think of when discussing small business loans. Lump sums of cash are borrowed by the debtor or applicant according to specific terms. The terms can be anything from a fixed or variable interest rate to the length of the payment schedule.

Most small business loans can be paid off in installments or can be revolving. However, the latter is more common for lines of credit. Whichever party is the legal debtor is the party that can deduct the loan interest. Therefore, if a small business is owned by two people and both people are on the loan agreement, each can claim 50% of the interest paid for tax deductions.

Short-Term Loans

Short-term loans are similar to term loans. They simply have shorter repayment schedules (typically less than a year). The interest that can be deducted is any interest paid within that tax year.

Lines of Credit

A line of credit (LOC) is similar to a credit card. A business entity or owner is approved for a line of credit for a certain amount of money, such as $50,000. The LOC holder can then draw on this amount to make business purchases whenever they need to and then pay back the amount or amounts, including interest. Any interest paid on the amount or amounts withdrawn from the LOC can then be deducted from business taxes when the time comes.

Merchant Cash Advances

Merchant cash advances (MCAs) are not technically loans. However, they are upfront lump-sum payments similar to loans. Instead of pledging to make payments, a business owner pledges future sales as collateral for the cash advance. These advances are typically taken out by a retail business that doesn’t generally qualify for traditional business loans, short-term or otherwise.

For example, if a retail business pledges $30,000 of its credit card receipts for a $25,000 lump sum, the company advancing the cash would take its portion of the receipts, usually 15 to 35%, until the $30,000 pledge is paid back. Any fees associated with the payments may be deducted from taxes.

Personal Loans

You can use a personal loan to fund business purchases. In fact, you can use a personal loan to 100% fund your business. If you do so, you can deduct all the interest you pay on your taxes. If you only use a portion of your personal loan for business expenses, then you can only deduct that same portion of interest on your taxes. Keep in mind that taking out a personal loan — or any loan for that matter — can affect your personal credit score. It all depends on how the loan is acquired.

Loans for Acquisition

A loan for acquisition is a loan taken out to buy an existing business. You can take out a loan to buy an existing business for two purposes: to actively run it or to simply own the business, possibly to dissolve it. If you take out a loan for acquisition for the latter purpose, you cannot deduct the interest of your loan payments as this is considered an investment. If, however, you intend to run the business as your own, you may deduct the interest from payments of the loan.

There are many institutions at which you can get business loans and lines of credit. The best course of action for any business owner is to speak with a financial professional to find the right loan or financial option which allows you to deduct as much interest as possible.

Apply for a commercial loan!

Idaho Trust Bank was founded by two brothers who built a successful law practice before starting a bank. When it comes to business banking, business succession planning, and commercial loans, we help clients create and preserve wealth for generations. To apply for a new commercial loan, contact a business lender or visit one of our full-service branches in Boise or Coeur d’Alene, Idaho.

The information provided herein is for general guidance only and should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles on this website are not intended to be used and cannot be used by any taxpayer for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer.

Tax law is subject to continual change, and the information in this article is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.

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