Can I Deduct Interest on Loans for My Small Business?
In general, the IRS allows you to deduct interest on business loans. However, like nearly all tax matters, this general guideline is subject to caveats and exceptions. The specifics of deducting interest for your small business are more complex.
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Deductible Interest
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Interest on a loan for your small business is considered deductible, as long as it meets three standards. You -- or the business -- must be legally liable for the debt. There must be an honest intent between you and the lender that the loan be repaid. There must be a legitimate creditor-lender relationship between you and the lender. The loan need not be entirely for your business. In the case of a loan with proceeds split between you personally and your small business, a proportional amount of the interest would be deductible.
Unclear Interest
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Some loans make it clear what part of a payment is interest, and what part is not. Some installment plans make this less apparent, often in an attempt to hide what may be exorbitant interest rates. The IRS assumes that payments on any loan -- including loans of this type -- go first toward paying any interest from that payment period, then get applied to the principal. If you have a loan with unclear interest, find the finance charges in your contract and apply this IRS guideline.
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Nondeductible Interest
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The IRS forbids deducting interest from some loans and sources. You may not deduct interest you pay with funds from another loan, nor may you deduct fees charged to have money available to loan, but not actually loaned to you. Interest on taxes in not deductible, even though the interest is charged to the business. You may not deduct interest on loans taken from a life insurance policy taken out as a key member insurance for the business. If you capitalize the interest on a long-term project, this may or may not be deductible.
Below-Market Loans
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A below-market loan is one in which the interest charged is below the federal guidelines, or significantly below the market rate for a loan of that type. The interest on these loans is deductible as a business expense. However, under some circumstances, the difference between your actual interest and the customary interest may be considered income for your business. This is especially applicable if the low interest rate was the result of forgiveness by your lender.
Common Sense Caution
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Tax law, especially business tax law, is complex and carries heavy penalties for error. If you have any questions about whether a specific loan's interest is deductible, you should consult a tax professional. An accountant or tax lawyer is equipped to answer your question and protect you from the financial repercussions of error.
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