Changes were made to business loan tax deductions in the Tax Reform Act of 1986, but not to the extent the personal interest rules were changed. From time to time, it’s good business practice to review the numerous loan interest deductions you can take in order to reduce your business tax burden.
Business Loan Interest
Generally speaking, business loan interest payments are deductible regardless if it’s interest on a bank loan, an online loan, a line of credit, or even your company credit card. These deductions hold true even if you used your personal assets as collateral to secure the loans.
The deciding factor as to the deductibility of business loan interest is how the loan funds are used. Did you buy a pleasure boat for personal use on the lake? If so, no interest deduction allowed. If you can show you purchased the boat to show your real estate clients lakefront property, chances are your interest on the boat loan will qualify as a deductible business expense.
One point to remember is that you can only take the interest deduction after you’ve spent it on a business expense item. Holding the funds in a bank account makes any interest deduction invalid. Knowing this, businesses should use caution about the amount of money they are borrowing. The interest payments on any funds left over and not used are not tax deductible.
It’s also important to remember that the money you borrow for personal purchases is not tax deductible. As a business owner, you should try to avoid paying this kind of interest whenever possible. The wise choice if you need to borrow money is to use loans for business expenses only and use your business earnings to pay off personal debts.
Automobile Loan Interest
If you can show you purchased a car for company business, the interest on that loan is deductible. Whether you can use the actual expense method if a standard mileage rate expenses has no bearing on deducting the full interest amount of the loan.
If you own more than one car, and you can prove the business car is used exclusively for business purposes, the interest on the loan is 100 percent deductible. If not, and the car is used for both business and pleasure, then it behooves you to keep accurate records to determine what percent you can allocate to both. If your records show you only used the car for personal use on weekends and that amounts to 30 percent of the usages, then you can deduct 70 percent of the loan interest as a business expense.
Loans From Family and Friends
Family loans can be tricky. The IRS will scrutinize loans from friends or family members much closer than hands-off loans from banks or other commercial lenders. Accurate record keeping is a must. All of the transactions for a personal loan for a company’s usage must be fully documented and provable. In addition, you will need to be able to prove you actually paid interest on the loans and funds changed hands.
Interest on Loans to Purchase a Business
Red flags are raised when funds are borrowed to buy a business and you deduct the interest on those loans. The questionable part of these transactions is if the loan is considered a business expense or an investment expense. Because there are a number of factors that determine which is which, consulting with a professional tax consultant is highly recommended.
Non-deductible Business Interest Expenses
No discussion on tax deductions for interest on loans would be complete without reminding us which types of interest are not deductible. They include:
- Loans for personal use.
- Interest on past due taxes (unless you’re a C corporation).
- If your business taxes are paid on a cash basis, any prepaid interest payments made in the current year.