For any business, working capital is an essential metric representing the operating liquidity available to the business.
Business loans are essential aspects of working capital as many businesses may be in need of credit facilities to keep the operations of the business going.
A business loan specifically refers to a loan that is intended to be used for business purposes strictly.
It is an inflow of resources into the business in form of debt and will have to be treated with care as it influences the business in many ways that some business owners fail to understand.
Business loans interact with taxes in a number of ways and it is essential that every business owner understands how this happens and how to avoid mistakes that will either make you pay more taxes than you need to pay, or land you in trouble for including items that are not deductible in your tax return.
To put things in the right perspective, we are going to extensively consider some of the major questions most business people may be asking based on the interaction of business loans and taxes.
What should business loans be used for?
We understand that you know that a business loan should be used for business purposes, but this question is treated here to emphasize the importance of respecting businesses as legal entities.
Business loans should never be used for personal needs.
Doing so could jeopardize the business and result in certain little alterations that will affect the business negatively in the long run.
Be it any form of personal need (especially personal tax), never use a business loan to take care of it.
What is the true nature of business loan in a business?
A proper understanding of the interaction of business loan and taxes should be rooted in the understanding of what a business loan truly is to a business.
It is indeed a cash inflow but is definitely not an income. If you treat it as an income, so many things can go wrong.
It is a debt you are expected to pay in full (with interest) and should be regarded as such unless the loan is forgiven.
So a business loan is not taxable?
At this point, we will go with the idea that business loans are not taxable. This is so because it is not a business income but a debt.
A business loan can, however, be taxed if the loan is forgiven.
If all or part of an interest loan is forgiven, the amount that is forgiven becomes an income and will have to be taxed.
So, at this point, you will have to pay income tax on the amount forgiven.
How should interests paid on loans be treated with regards to taxes?
The interests you pay for using other people’s money is not just an ordinary outflow from your business; it’s an expense and should appear as an item in your deductibles.
It is, however, important to note that you can only deduct interest paid for loans that were strictly used for business expenses.
If all or a portion of the loan is used for personal needs, the interest paid on such amount is not deductible, and it will be illegal to do that.
How is the repayment of business loans treated with regards to taxation?
Some like to consider repayment of business loans as expenses; this is not true.
Though it is an outflow of resources from your business, business loan repayment is not an expense and therefore not deductible.
Just as they are not considered as income when they were obtained, they are not to be considered as expenses when they are paid pack.
They are simply resources (money) that entered your business and exited.
But you also have to remember that the interest you paid for using them is an expense and should form part of your tax deductibles.
Are there business expenses that do not qualify for deductibles?
Throughout this article, we have emphasized that business expenses qualify for deductible and any interest paid on business loans used for business expenses should be part of your deductibles.
It is important, however, to state at this point that there are some interest expenses that do not qualify for deductibles.
These expenses are tax related and are as follows:
- Interests on overdue taxes or tax penalties (this can be deducted by C-Corporations only)
- Interests for loans to pay taxes or fund retirement plans
- Interests for loans of more than $50,000 that are borrowed on a life insurance policy for business owner(s) and employees.
So do we recommend using a business loan to cover tax expenses?
While business loans (as working capitals) can be great in keeping your business afloat, it is not expected to be used on expenses that do not qualify for deductible.
The interest paid for such uses (which is actually a real expense) cannot be deducted from your tax returns and will be an economic loss.
You can use business loans for all business expenses, but not expenses that has to do with taxes.
To know more about how business loans impact your business tax returns, talk to an experienced accountant at Priority Funding Solutions, Inc. We are always ready to listen to you and advise you on the best way to achieve your short and long term business goals.