Is Business Loan Interest Tax Deductible? Limitations in 2023
You can claim a deduction on your tax return for the business loan interest you paid during the year. Qualifying business loans include term loans, lines of credit, and even credit cards. However, you can only claim a deduction if your loan was for a business purpose, like purchasing assets or paying expenses.
If you’re a small business owner, this is a powerful deduction to use; however, it’s subject to some limitations. Businesses with more than $27 million in annual average gross receipts may have their deduction for business interest limited, but smaller businesses can deduct 100% of their business interest
You Can Claim Business Loan Interest Deductions When
You Cannot Claim Business Loan Interest Deductions When
What is a business loan? It is money or a line of credit that you can get from a lender or other person to help with your startup or operation costs. Most of the time, your business has to pay the loan in installments that include both the principal and the interest.
You can deduct interest on a debt if you meet all the following requirements:
- You are obligated legally to repay the loan
- Both you and the lender intend that the loan be repaid
- You have a debtor-creditor relationship with the lender
Business Interest Limitations & Exceptions
Generally, the most you can deduct for business interest expense in a given tax year is limited to the sum of:
- Business interest income.
- 30% of the adjustable taxable income.
- Floor plan financing interest.
You can use IRS Form 8990, Limitation on Business Interest Expense Under Section 163(j), to figure out your limitation. Any business interest above the limit can be carried forward indefinitely to future years.
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Exceptions for Small Businesses
If your business has $27 million or less in average annual gross receipts, then your business is not subject to the limitation on interest expense—unless the business is a tax shelter.
Using the three tax years before the current year, you can figure out the average annual gross receipts. If this is a new business, then you will use the number of years your business has been in existence to calculate the average annual gross receipts. All businesses qualify in their first year of existence.
Allocating Business Interest When Loan Proceeds Are Used for Multiple Purposes
When you borrow money, you can deduct the interest expense based on how the money is used. If you use the loan for more than one purpose, the interest must be categorized (allocated) according to the purpose for which you used it. This is known as the interest tracing rules. For instance, if you use 60% of a loan for business purposes, then only 60% of the interest paid is business interest.
In January 2022, Mr. X, a sole proprietor, took out a loan of $10,000 with a monthly interest rate of 5% from Big Money Bank for his growing tax practice. Big Money Bank gave Mr. X five years to repay the loan.
Mr. X spent $3,000 on new business equipment and $5,000 for a new tax research tool. Mr. X used the last $2,000 to pay the mortgage on his primary residence. His home does not have a home office, and he does not use it for any business purposes.
Using the interest tracing rules, the only deductible business interest Mr. X can claim during the tax year are the interest associated with the tax research tool ($5,000) and the purchase of the business equipment ($3,000). The $2,000 for mortgage can be linked to a personal expense, so any interest on it is a personal expense and is not tax-deductible.
Where To Claim Business Interest Deduction
The form or schedule you use to claim this deduction will depend on how your business is set up:
- Sole proprietor: IRS Form 1040, Schedule C, Line 16
- Partnership: IRS Form 1065, page 1, Line 15
- Corporation: IRS Form 1120, page 1, Line 18
- S corporation (S-corp): Form 1120S, page 1, line 13
Frequently Asked Questions (FAQs)
Interest charged on income tax assessed on your individual income tax return is not a business deduction even though the tax due is related to income from your trade or business.
If you use the cash method of accounting, you can’t deduct accrued interest on one loan you pay by borrowing money on a second loan from the same lender. Once you start making payments on the new loan, you can deduct the interest cost.
No, you can only claim a deduction for the interest portion of your loan. You may be able to claim a deduction for how the principal was spent when the loan proceeds were received.
While taking out a loan for your business may be a bit stressful, you can breathe a slight sigh of relief knowing the IRS usually allows you to claim a deduction. If you’re filing a tax return for your business this tax season, do not miss out on the opportunity to claim this powerful deduction.