One of the most important questions that a small business owner should ask is “Are business loan payments taxable?” Of course, they are – but how much? In this article we will explain. To the fullest extent possible, we will discuss both standard and balloon payments, both types that are potentially tax deductible.
The most common type of payment made on a commercial real estate loan is interest. Interest paid on principal is not tax deductible. If interest on the principal is more than six percent a year (which occurs when the balance decreases) the payment may be tax-deductible to a maximum of three percent a year.
Balloon payments are payments that end after a period of time. This can be as short as a few months or as long as a year. Although the principle stays the same throughout the period, capital gains may be realized at the end of the period. Capital gains may be subject to federal and state taxes. Depending on where the payment is made, capital gains may be exempt from self-employed income tax as well as from income tax on dividends received from an account owned by the business.
A commercial bridge loan may be used to pay interest and principal for a one-year period or to make payments for one year and in some cases longer. However, if a company decides to repay the bridge loan within a year, the interest and principal may be considered taxable. The payment period may start early in the tax year or be ended early in the following year. This makes the payment capital gains tax deductible up to the first $500 of the loan amount.
Business owners may be able to deduct the interest paid on purchase orders and installment purchase agreements. Also, interest on loans may be deductible if it is paid over a certain amount of time. Interest paid on qualified student loan debt is also deductible as long as the student is not delinquent. Interest on a business line of credit is tax deductible.
There are many other deductions that can be applied to loan payments. These include educational expenses and medical expenses. Home ownership and charitable contributions are deductible business expenses. The IRS has specific instructions on how to claim all tax deductible expenses.
Business owners may be able to claim deductions based on their income level. The higher the adjusted gross income (AGI) the more deductions are available. Certain expenses, such as education, may be claimed even if the borrower has not been awarded a loan. In addition, payments made for childcare and transportation are deductible.
It is important to understand if a loan or refund is being claimed for a tax deductible expense. Before making any tax-related decisions, always consult a tax professional. If you are unable to determine whether a tax deductible expense is eligible, an accountant with experience in tax . . . . . . law may be able to assist you with your questions. With a little diligence, you will be able to decide if your business loan payments are tax deductible.