Are your business loans tax deductible? Find the answer to this as well as other tax-related loan questions.
Business taxes can be quite complex. There’s a lot that you have to figure out if you want to ensure you fulfill your tax obligations correctly. For small business owners, understanding finance is crucial, as small businesses have specific tax obligations and benefits that can impact their financial decisions.
This is especially true if you decide to take out a loan.
A loan can be an excellent way to cover your business expenses. Sometimes they can even save your business from failing. Small business loans are commonly used for various purposes, such as covering operational costs, purchasing assets, or providing working capital to support daily operations.
A business in the accommodation industry incurred many expenses that it couldn’t meet. Little by little, the business was getting buried in debt. Costs were piling up and the owner couldn’t find a way to get out of it.
To overcome the problems, the owner decided to take out an unsecured loan. The owner’s personal credit wasn’t ideal, so this was the best option.
The owner took out $90,000 over a 12-month period. He put the funds to good use, using the loan to cover operational costs and provide working capital, and managed to get his business out of debt.
But what does the ATO think about you taking out a business loan? Let’s answer some popular questions that business owners have with regard to tax implications.
Can Business Loans Be Written Off?
As a business owner, you might struggle to figure out how deductions work when you borrow money. After all, aren’t all business expenses deductible?
According to the ATO:
‘You can claim a tax deduction for most expenses from carrying on your business, as long as they are directly related to earning your assessable income.’
However, business loans aren’t always directly related to the business activities that earn income.
Therefore, you can only write off the cost part of your business loans, i.e. the interest. Interest payments are generally deductible, but only if certain conditions are met. The loan principal, of course, is business liability and not a cost. After considering deductibility, keep in mind that different rules may apply depending on your business structure or how the loan is used.
As you know, the amount of money that you repay includes interest paid on that loan. And those interest expenses are the portion of the loan that you can write off, provided the payment of interest meets ATO requirements. Specific rules apply as set by the ATO, so you must ensure all criteria are satisfied.
Keep in mind, though, that this is only true if you use the entire loan for business purposes. Interest accrued on the loan amount that you spend on personal items isn’t deductible.
It’s very important that you keep track of every loan repayment that you make in a fiscal year. You must include proof of interest paid and maintain proper loan agreements when you submit your tax return. Either that, or you can obtain a statement from your lender.
Is Your Loan Considered Taxable Income?
Some may not understand how taxable income works when it comes to using external business financing.
Usually, the loan that you take out doesn’t fall under taxable income. This is because external financing is just money that you’ll pay back to the lender. While there are some exceptions, they don’t apply to loans that you can take out from a bank or an online lender.
However, there is an exception that applies universally, regardless of your lender. If all of your debt gets forgiven, the amount that the lender forgives is taxable income. Even if you didn’t pay any taxes when you first received the funds, this makes it taxable. For those in the business of lending money, such as banks and financial institutions, the interest income earned from lending money is considered taxable income.
Is Loan Repayment a Business Expense?
If you take out a business loan, you’re doing it to cover some of your business expenses. You might have come upon a rare opportunity that you want to take advantage of. Or maybe you run a seasonal business and you need money to get through the slow season.
Whatever the case may be, you’ll be spending the money on something business-related. But is the repayment of that money a business expense?
It’s not for tax purposes. As mentioned, the principal of your loan is a liability, not expenses.
The interest paid, on the other hand, is an expense. It’s the cost of the loan, just like any other business costs. Some business loans may offer favorable terms, such as lower interest rates, which can reduce the overall cost to the business.
What Else Can You Write Off?
Many business owners may not know what business expenses are tax deductible and therefore they overlook business expenses that they can deduct.
Here are some expenses that are tax deductible:
- Business credit card interest
- Employee gifts
- Tax preparation fees
- Education
- Healthcare tax credit
- Professional fees
- Insurance
If you are a sole trader or partner, you may need to report these deductions on your individual tax return.
There are many more expenses that you can deduct so ensure to include all of them so that you don’t miss out on opportunities to save money on taxes. It is important to maintain accurate records to substantiate your claims and ensure you claim all eligible expenses.
Business Structure Considerations
When it comes to business loans and tax deductions, your business structure can have a significant impact on your tax obligations and the way you claim deductions. Whether you operate as a sole trader, partnership, or company, each structure comes with its own set of rules for reporting business income and claiming deductions on your tax returns. For example, sole proprietors and partnerships typically report business income and deductions on their individual tax returns, while companies must file separate tax returns and may be subject to different tax rates and regulations set by the Australian Taxation Office (ATO). Understanding how your business structure affects the deductibility of business loans and other expenses is crucial for staying compliant and making the most of available tax benefits. Business owners should consult a tax professional to ensure their structure is best suited to their needs and to navigate the complexities of business loans, income, and deductions effectively.
Business Expense Tracking
Keeping accurate records of your business expenses is essential for claiming tax deductions and staying compliant with ATO requirements. Business owners should make it a priority to maintain comprehensive and organized records, including receipts, invoices, and bank statements for all business-related expenses. This is especially important for tracking interest payments on business loans, as these payments are often tax-deductible. By implementing a reliable accounting system and regularly updating your records, you can ensure that you are taking advantage of all eligible deductions and avoid missing out on valuable tax savings. Seeking assistance from a tax professional can also help you streamline your expense tracking and ensure that your business is prepared for tax time. Remember, accurate records are not just a best practice—they are a requirement for claiming deductions and protecting your business from potential penalties.
Maximizing Tax Benefits
To get the most out of your business loans and other expenses, it’s important to understand which costs are tax deductible and how to claim them effectively. Business owners can claim deductions for a wide range of expenses, including interest payments on business loans, operating expenses like rent and utilities, and even certain capital expenses related to business assets. Deductions may also be available for costs associated with maintaining a safe workplace or investing in new equipment. By keeping accurate records and staying informed about what expenses are tax deductible, businesses can reduce their taxable income and improve their cash flow. Don’t overlook the opportunity to claim deductions for all eligible payments and assets—consulting a tax professional can help ensure you’re maximizing your tax benefits and making the most of your business finances.
Common Tax Pitfalls to Avoid
Navigating the tax implications of business loans and deductions can be tricky, and there are several common pitfalls that business owners should watch out for. One major mistake is failing to keep accurate records, which can lead to missed deductions and even penalties from the ATO. Another common error is claiming deductions for personal expenses that are not directly related to earning assessable income—this can trigger audits and result in fines. It’s also important to understand the rules around tax deductibility and ensure that all claimed expenses are legitimate business costs. To avoid these pitfalls, businesses should seek assistance from a tax professional, maintain thorough records, and stay up to date with the latest tax rules. By doing so, you can take full advantage of available deductions while staying compliant with tax regulations.
Know Your Taxes
Hopefully, you now have a better understanding of how taxes work in relation to business loans. Knowing this is vital to determining if a loan makes sense for your business.
It certainly helps to write off the interest that you pay on your loan, as it’s the biggest loan-related expense that you’ll incur.
As explained in the beginning of this article, taking out an unsecured loan is a great way to support your business, whether it’s for growth or to get out of temporary hardship.
If you need a loan, visit our website to find out what we have to offer. And if you’re ready to apply, use our online form to lodge your application. This will take less than five minutes.
Conclusion and Final Thoughts
In summary, understanding the tax implications of business loans and deductions is essential for every business owner. By keeping accurate records, consulting a tax professional, and being aware of which expenses are tax deductible, businesses can take advantage of valuable tax deductions and minimize their tax liability. Staying compliant with ATO rules and maintaining proper documentation will help ensure your business is well-prepared at tax time and able to maximize its cash flow. Remember, the right approach to business loans and tax deductions can make a significant difference to your bottom line. Take the time to get it right, seek professional assistance when needed, and make sure your business is taking advantage of every opportunity to save on taxes.
