Is Business Loan Interest Tax Deductible?

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Do you need some money to launch your small business, tackle an existing business project or expand your marketing efforts? The Internet has no shortage of lenders offering loans to businesses. If you decide to take out a loan, confirm it is from a reputable source.

To legally write off the loan interest, the use of the money must meet the IRS requirements. Namely, a business loan must be intended only for business purposes. An executed loan agreement must define the debt, principal amount, interest rate, length of repayment, etc.

Your lender will provide a monthly statement detailing your payment amount applied to the principal and towards the interest. This statement is proof of the total amount of interest paid.

You are responsible for documenting how the loan proceeds were used for your business. Your loan statements and supporting records will then meet the requirements for the interest to be tax-deductible.

In this article, we will provide you with some examples that you may find helpful.

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Are business loan payments tax deductible?

As you would expect, there are IRS requirements to qualify to claim the interest deduction. As per the IRS website: You can deduct interest on a debt only if you meet all the following criteria.

  • You are legally liable for that debt.
  • Both you and the lender intend that the debt be paid in full.
  • You and the lender have a genuine debtor-creditor relationship.

Publication 535 (2021), Business Expenses | Internal Revenue Service (irs.gov)

You can only deduct interest payments for loans where you are legally liable. So, as an example, if you help your Son or Daughter through a tight spot by making his/her business loan payments for a few months, you cannot claim an interest deduction from his/her loan.

How much of my business loan payment is deductible?

Each payment consists of two parts. The loan principal, in other words, the amount of money lent to you. And second, a stipulated interest rate. Some loans are fully amortized, meaning that if you choose to make each defined monthly payment, the loan account will reach zero at the end of the term.

If 100% of the loan proceeds are used for business purposes, 100% of the interest paid would be a deductible business expense. Be sure to work with your tax advisor to properly document how you used the loan proceeds to support taking the interest deduction fully.

For Illustration:

  • George borrows $400.00
  • 4-year term at 10% interest.
  • One annual payment is required.
  • The annual payment is fixed at $126.19

Since the $400 benefited the business, George would deduct each year’s cumulative interest amount. You will notice that the amount paid on the principal increases each year while the interest decreases.

Principal Payment Interest Payment Total Payment Remaining Balance
1 $86.19 $40.00 $126.19 $313.81
2 $94.81 $31.38 $126.19 $219.00
3 $104.28 $21.91 $126.19 $114.72
4 $114.72 $11.47 $126.19 $0.00

Read also: What Is a Business Plan?

Qualifying for a Business Loan Interest Deduction

As a taxpayer, you can take any deduction you wish. On the other hand, your responsibility as a taxpayer is to retain the documentation to support the deduction. If the IRS questions a particular deduction, you can provide the supporting documentation. IMPORTANT: When dealing with the IRS, many people find it beneficial to be represented by an authorized agent. A professional tax expert understands the law and how to respond appropriately.

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