You are excited about the kick-off of your new business, and you need sufficient finance to keep it running. If you are thinking of small business loans to get the business running or get new equipment, you must know how it affects tax payments.
Business owners will be excited to hear that most loans do not make you pay more tax. When you get a huge sum of money from a lender, it is different from earning money from your small business. Therefore, the principal amount will not be taxed.
Depending on the loan type and your business’s legal structure, you can reduce your tax burden by deducting your interest payments. The truth is, small business loans will always come with risks, but when interest payments are written off as business expenses, the extra costs become quite palatable.
Are business loans classified as taxable income?
Not all small business loans are classified as taxable income, and this is because you are paying back the money. There are exceptions to this, and they apply to loans that are not small business loans from lenders or banks.
The major exception is if your debt is written off. That way, the forgiven amount becomes the taxable income. So if you didn’t pay taxes initially after receiving the funds, the forgiveness implication transforms the loan into an income.
Business loan interest deduction
If you remove business loans, the lender charges interest. This interest is the percentage of the principal or original loan amount. Hence, this means you have to pay the interest alongside the principal. Based on the IRS directives, the annual interest paid on a business loan is written off.
With the interest tax deduction on a business loan, you can remove the amount paid in business loan interest through your tax liability. The implication of this deduction is a reduction in your owed taxes.
Conditions that determine if your business can claim the interest expense deduction
According to the US’s Internal revenue service, interest tax deduction can be claimed if you intend to use the loans for business purposes. Also, business loan interests can only be deducted if the following conditions are met:
Legally liable for the debt: When audited, you have to tender the paperwork showing the debt’s terms and signatures.
Documents showing payment intentions from you and the lender: You have to show that payments are made, and the lender is playing their part too. If there is no activity in a person to person loan, it will raise suspicion, and interests might not be deducted from the business loan.
Legit creditor-debtor relationship: You have to prove that you have a true and working creditor-debtor relationship. A gentleman’s agreement between you and your lender holds no water.
If you want to fulfill the above three conditions, you have to keep the loan agreement intact, pay regularly and confirm your lender’s processes payments.
One mistake you should avoid making is claiming the deduction for interests on loans if it is used for personal expenses. However, if the loan is both for personal and business expenses, the interest cut for business expenses can be deducted.
Conclusion
Small business loans should always have a positive effect on your business. It should be a profound avenue to achieve great results in the long-term. With this, there is an advanced cost, and interest payments are a good example of this cost.
Having to write off such costs as tax deductibles is a big benefit to small business owners. Hence, you have to know the tax conditions that come with any product/service you select. To make things easier, you can discuss with your accountant or tax professional to ensure the maximization of your tax savings.