Are Business Loans Tax Deductible?
What you can -and can’t- claim on your tax return
When you own a business, finding ways to reduce your tax burden is a priority. Come tax time, you’re bound to be on the hunt for anything you can write off so your payment to the IRS is as low as possible.
The search for deductions might have you wondering whether business loan payments are tax deductible. After all, they are a business expense you must pay monthly, and those payments cut into your overall income.
So, is a business loan tax deductible? Unfortunately, business loan payments are not (entirely) tax deductible. It’s not all bad news, though. If you meet specific criteria, you can claim some interest paid on the loans to reduce your taxable income.
The basics of business loan payments
Before we discuss the intricacies of deducting business loan interest, it is helpful to review the basics of loan payments.
Loan payments usually have two components: principal and interest. Depending on the type of loan, the lender applies a portion of the payment to each component. If you have a term loan, for example, a larger percentage of the payment goes toward the interest first, then decreases as you pay the balance.
The principal portion of a business loan payment is not tax-deductible. However, interest paid on a business loan is generally tax-deductible as long as you use the money for business purposes. The IRS allows companies to deduct the interest as a business expense if they use the loan funds to:
- Purchase business assets
- Cover operational expenses
- Fund business expansion
- Manage cash flow
In short, if you used the money you borrowed for the intended purpose and can prove it, you’ll probably be able to deduct the interest.
The tax implications of a business loan
Why can’t you deduct payments toward the principal from your taxes? The simple answer is that the IRS does not consider a business loan to be income. Their rationale is that because you are repaying the borrowed money, your repayments don’t count as money spent on the business.
When you take out a business loan, the IRS does not consider it taxable income. This is good news if you borrow a substantial amount of cash, adding it to your business income could mean a higher tax bracket (a range of incomes subject to a certain income tax rate) and a bigger bill.
But again, you may still be able to deduct the business loan interest you pay. Depending on the amount you borrowed, you might pay hundreds or thousands of dollars in interest on loan payments throughout the year, which can become a significant tax deduction.
One caveat: the IRS does place limits on deducting business interest. However, most small businesses are exempt from this limit. As of 2023, businesses that earn more than $29 million in gross receipts (the total amount of money a business earns from sales or services before expenses) generally cannot deduct all the business loan interest; if your company falls below that threshold, you likely qualify for the entire deduction.
Does your loan qualify for tax-deductible interest payments?
As you might expect, the IRS rules surrounding tax deductions for business loans are complex and ever-changing. For example, not all loan types qualify for an interest payment deduction. You can typically only deduct business loan interest on the following:
- Personal loans when you use the money for business-related expenses; if you use some of the funds for personal expenses, you can only deduct the interest from the portion of the loan you used on your company.
- Auto loans for vehicles used for business; again, if you use the vehicle for non-business purposes, you’ll have to determine the percentage of business vs. personal use to calculate how much interest you can deduct.
- Short-term loans; if you pay off the entire loan in a year, you can write off all the interest.
- Term loans, with the caveat that the allowable deduction will decrease over the life of the loan since these loans require you to pay more interest up front.
- Lines of credit, but you can only write off the interest on the money you withdraw from the credit line this year.
- Expansion loans, provided that you intend to operate the business that you purchase. Otherwise, the purchase may be considered an investment, which prevents you from taking the deduction.
The IRS will allow you to write off the interest on a business loan only if: you paid it during the tax year, the loan disbursement was used strictly for business expenses, and the loan falls into one of these types.
Exceptions to the loan interest deduction rules
Sometimes, you cannot write off the interest paid on a business loan.
These exceptions include:
- A loan you took to pay overdue taxes or tax penalties; Schedule C companies can take this deduction.
- Loans you have not used, i.e., the disbursement is just cash in your bank account, or the bank holds it for you to use when you need it.
- Loans used for certain real estate expenses, like points and origination fees on mortgages.
- Loans of $50,000 or more from life insurance policies.
- Fees to keep funds on standby; if you have money available but don’t actually use it, you can’t deduct the fees you pay the lender for this service.
- Capitalized interest; when you use a business loan for a long-term asset, you have to add the capitalized interest to the property value rather than take it as a tax deduction.
Refinancing a loan can also influence the availability of interest deductions. If you refinance a loan or take out a second loan to pay off an existing one, you generally cannot claim the interest deduction on the first loan. However, you can deduct the interest you pay on the second loan.
Another loan-related deduction: expenses you pay with the business loan
Using a business loan to cover certain expenses might have some tax advantages. If you use the money for qualified business expenses, you might be able to deduct those expenses to reduce your tax bill.
In short, if you use the loan to purchase equipment, like office furniture or machinery, real estate, or to cover construction costs to build, remodel, or repair your physical location, you can deduct those expenses from your taxes.
Documentation is the key to business loan deductions
If you have business loan-related deductions for your tax return, you must provide solid documentation that the loan is legitimate and that you paid the interest you claim.
Among the facts you’ll need to prove include:
- Your responsibility for the debt
- Proof of repayment
- Proof that you spent the funds from the loan on business expenses
- Evidence that you have a debtor-creditor relationship with the lender
- Proof that the lender is a legitimate and reputable funding source; in other words, you can’t borrow money from friends or family and deduct the interest you pay them.
As you make payments on the loan throughout the year, keep track of what you pay and the portion that goes toward interest. The lender will provide an interest statement at the end of the year with the total amount you paid. Compare this document against your records for accuracy.
Avoid common misconceptions about business loans and taxes
We cannot stress enough the importance of working with a qualified tax professional when filing your business taxes. There are many pitfalls when taking deductions that can turn into costly mistakes.
These include a few common misconceptions, including:
- All your loan payments are deductible. Only the interest portion of loan payments is deductible. Otherwise, the entire loan would be tax-deductible. Wouldn’t that be great?
- You can deduct interest paid on personal loans used for business. Whether a loan’s interest is deductible depends on its purpose, not its type. If you use every penny of a personal loan for business, you can deduct the interest, but you must have detailed and accurate records proving that you did.
- You can take deductions without proof. Documentation is essential for every tax deduction you take, not just loan interest. If your business is flagged for an audit and you don’t have proof to support your claims, you could land in hot water with the IRS.
The option to write off business loan interest on your taxes can significantly benefit a small business owner. Remember, any time you borrow money, it should be with the intent to help your company in the long term. While there may be an upfront cost (in this case, interest on the loan balance), the outcome should be a stronger, more successful company on a more solid financial footing. Therefore, you should discuss the tax ramifications of any loan before you sign a single promissory note to ensure you’re putting your company in the best possible position.
Finance Factory will help your business make smart financial choices
Whatever your business dreams for 2025—a new location, upgraded equipment, new product lines, or more market share—Finance Factory can help you make them a reality. We’ve been a reliable source of funding entrepreneurs for over two decades. Whether you’re a new or well-established business, we can connect you with alternative financing options that help you reach your goals while staying on secure financial footing.
Connect with us today to get the new year off to a great start. You can also fill out our quick, no-obligation application to see how we can help you grow your company in minutes.
