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If you borrowed money to start or expand your business, you may wonder how that financing will affect your already complicated taxes. Are small business loans considered income? Will you end up paying more in taxes because you borrowed money?The answer is, probably not. In fact, borrowing money to backup your business will in many cases lower your taxes. There are a few exceptions, however, so read on to learn more about how financing can impact your taxes, along with other important things to keep in mind when filing your business tax return this year.
Do Business Loans Count as Income? The Short Answer
Not usually. The reason is that this is money that you will be paying back. So while a loan of, let’s say $100,000, puts money in your business bank account, you’ll be returning that money — along with interest — over time, so it’s not actually considered income.
Do Business Loans Count as Income? The Long Answer
There are many different types of business loans and, in most cases, they are not considered income. There is one notable exception, however. If you negotiate with a creditor or a lender to reduce your debt, any amount of debt that is forgiven is considered income and you will owe taxes on the amount. So, even though you didn’t pay taxes on it when you received the funds, the act of forgiveness changes it from a loan to income. There is also an exception to this exception: If you received a Paycheck Protection Program (PPP) loan as a result of losses during the pandemic, and the PPP loan is forgiven, the amount of the loan is not likely going to be taxed as income by the IRS.Recommended:Applying for a Small Business Loan in 6 Steps
How Small Business Loans Affect Taxes
While you don’t typically pay income tax on a loan, getting a small business loan can still have an effect on your taxes. Here’s how.
Interest Repayment
The way small business loans work is that when you are paying it back, your loan payments are split between paying interest and paying down the loan principal. The part of your payment that goes toward interest is tax deductible, which means it will reduce your taxable income and allow you to pay less in taxes than you otherwise would. In order to take advantage of this tax deduction, you must have a true debtor-creditor relationship with the lenders (money you borrow from friends and family doesn’t count, even if you are paying them interest). Also, the money you borrowed must be used for assets and expenditures necessary to operate your business. If you spend the money in other ways, the interest will not be a deductible business expense.(Not sure what average interest rates for a business loan is? You might be paying too much!)
Common Business Expenses You Can Write Off
In addition to interest on business loans, other expenses that are ordinary and necessary to keep your business running are also likely to be deductible. This includes:Home office If you are working from home in a room that’s only used for your business, you can usually deduct home-related expenses for that room — rent or mortgage payments, utilities, and more.Commercial rent If you rent office space, these money payments will most likely be deductible.Utilities Expenses like phone, electricity, and internet for your business typically qualify as business expenses.Employee salaries Whether you pay full-time, part-time, or contract help, it’s generally all a business expense.Marketing Money you invest in advertising, content marketing, and social media management is generally considered a business expense.Office Supplies and equipment This includes computers, printers, paper clips, paper, pens, and anything you need to conduct your business.Professional dues Membership fees or dues you pay to trade boards, business leagues, civic or public service organizations, bar associations, etc., can usually be written off as a business expense as long as the membership is required for (or helps you perform) your business duties.Software Your business can typically write off software programs you bought or subscribed to like Microsoft Office or Adobe Creative Suite.Mileage If your business involves a lot of traveling by car, you can likely write off some of those expenses like mileage, tolls, and parking, though you’ll need to keep careful track during the year.Entertaining clients. Taking a client out for a meal at a restaurant (that isn’t lavish) where work is discussed is 100 percent deductible in 2021 and 2022.The key to claiming business deductions is to record each and every one of your expenses, being careful to always separate business and personal expenses, Be sure to save receipts and categorize all your business expenses for easy access in the future. This will make filing taxes easier since you can easily see what you spent money on for your business.
Common Business Expenses You Can't Write Off
There are certain expenses that, while they may seem ordinary and necessary, are not deductible. These include:Expensive gifts to clients Gifts given to your clients or customers are only deductible up to $25 a person. Entertaining clients Taking clients out to the theater or for a day of golfing is not deductible. Commuting expenses Driving your personal car to and from work every day or taking public transportation is not deductible.Contributions to political parties or candidates You may feel strongly about and support a local political candidate. That person may plan to invest in your industry. Even so, contributions to that candidate's campaign are not tax deductible business expenses.Membership fees to social clubs Even if the members may be clients or potential clients, membership fees to social or country clubs are not typically deductible. Here’s a quick comparison of expenses that you can and can not write off.
Qualified Business Expenses
Unqualified Business Expenses
Dues to professional organizations
Dues to social clubs
Taking a client to a restaurant
Entertaining clients
Travel to client sites
Travel to and from your office
Client gifts that cost $25 or less
Client gifts over $25
Personal Tax Returns vs Business Tax Returns
If you’ve always filed your own personal tax return, you might want to do the same for your business tax return. And, that may be doable, particularly if your tax situation is simple. Here are some key similarities and differences between personal and business tax returns.
Similarities
If you operate your business as a sole proprietor, little will look different in how you file taxes. You’ll file your business income along with all your other income as personal income on IRS Form 1040. The same goes for businesses with pass-through structures (meaning business income is passed-through to the owner), which include general partnerships, limited liability companies (LLCs), and S corporations.The tax return due date for these types of business is the same as for personal taxes: around April 15. The tax rate is also the same: For tax year 2021, it ranges from 10 to 35 percent. (You will also need to pay an additional 15.3 percent self-employment tax on income from your business.)
Differences
When you own a business, there may be additional tax forms you need to fill out besides Form 1040. Which ones depend on how your business is structured. C corporation owners file Form 1120, while S corporation owners must submit Form 1120S. Partnerships file an informational return known as Form 1065. If you have an LLC and want to be treated as a corporation or partnership for tax purposes, you will use Form 1120 or Form 1065 for your business taxes.Tax due dates also differ if your business is treated as a corporation. While individuals and pass-through entities file on Tax Day in April, S corporations and partnerships file around March 15.Also keep in mind that when you are operating a business, you will likely need to make estimated tax payments every quarter (on January 15, April 15, June 15, and September 15). Some businesses must also file monthly payroll taxes. Tax rates also differ. If you have formally established a corporate entity, there is a flat federal tax rate of 21% on business income no matter how much your business earns. Here a snapshot of personal tax returns vs business tax returns.
Similarities
Differences
Individuals, sole proprietorships, and pass-through businesses all file Form 1040 to report income.
Some business structures require other forms, such as Form 1120, Form 1120S, and Form 2065.
The filing date for individuals, sole proprietorships, and pass-through businesses is the same – around April 15.
S corporations and partnerships must file taxes around March 15. Estimated taxes are due January 15, April 15, June 15, and September 15.
The Takeaway
Most business loans are not considered taxable income. And, when paying one off, you can likely deduct any interest you pay from your taxable income.There are always exceptions when it comes to taxes. So it can be a good idea to consult a tax professional if you’re unsure about the validity of any business deduction.If you’re looking to grow your small business this year (and get some of the tax advantages of taking out a loan), there are all kinds of small business financing options to consider. With Lantern by SoFi, you can compare rates from multiple small business lenders without any obligation and just one application.
Frequently Asked Questions
Is loan repayment considered a business expense?
Can you deduct interest you paid on a business loan?
Is an SBA loan considered income?
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Photo credit: iStock/kate_sept2004
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About the Author
Susan Guillory
Su Guillory is a freelance business writer and expat coach. She’s written several business books and has been published on sites including Forbes, AllBusiness, and SoFi. She writes about business and personal credit, financial strategies, loans, and credit cards.
