What Is a Business Interest Expense?
A business interest expense is the cost of interest that is charged on business loans used to maintain operations. Business interest expenses may be deductible as an ordinary business expense for certain businesses.
Key Takeaways
- A business interest expense is the cost of interest on a business loan used to maintain business operations or pay for business expenses.
- Business interest expenses may be deductible if the use of the loan qualifies under tax law.
- Deductions do not apply to certain small businesses, farms, real estate investment companies, and certain utilities.
Understanding a Business Interest Expense
A business interest expense is any interest associated with a loan that is used to pay for business operations or associated expenses. The primary focus of a business interest expense, and therefore the importance placed on its classification, is the ability for the expenses to be deductible.
Generally, for loan interest to be deductible, the loan must be used to either purchase assets for the business or to pay for business expenses. If any amount of the loan is used for nonbusiness purposes, then the amount of deductible interest from the loan must be reduced proportionately. For example, any investment interest would not count as a business interest expense and therefore not be deductible under the tax laws for interest expense deductions.
Business Interest Expense Deduction
In the United States, the 2017 passage of the Tax Cuts and Jobs Act provided for several provisions that reduce the tax burden for businesses. Among the most significant changes is a reduction in the corporate tax rate to 21% from 35%, as well as a new 20% deduction on qualified business income. To offset those cuts, Congress placed new limitations on the amount of interest that would be deductible for certain types of businesses.
Before 2018, taxpayers were able to deduct business interest with some rare exceptions. With the Tax Cuts and Jobs Act changes, the deduction for net business interest is now limited to 30% of a taxpayer's adjusted taxable income.
The deduction limitation for taxable income does not take into account business interest expenses and income, net operating losses, non-business income (like gains from assets that were held as investments), and depreciation, amortization, or depletion. The limitation does not apply to interest earned from investments. The deduction for depreciation, amortization, or depletion is only applicable through 2021, so businesses that are capital intensive can expect higher tax bills in 2022.
Business expenses must be deducted on the proper tax form that correlates to the business for which the expenditure was made. Taxpayers who incur corporate business expenses cannot deduct this expense on their returns. The business must reimburse the taxpayer and then deduct the reimbursem*nt on the corporate return.
The Internal Revenue Service (IRS) has laid out guidance on business interest expense limitations.
Special Considerations
The aforementioned deductibility limitation does not apply to a few types of entities, such as small businesses, farms, real estate investment companies, and certain utilities. In this case, a "small business" is described as a company with average annual gross receipts of $25 million or less over a trailing three-year period. The three-year lookback ensures that companies cannot be broken up to come in under the $25 million threshold.
FAQs
Key Takeaways. A business interest expense is the cost of interest on a business loan used to maintain business operations or pay for business expenses. Business interest expenses may be deductible if the use of the loan qualifies under tax law.
What is an interest expense in business? ›
What Is an Interest Expense? An interest expense is the cost incurred by an entity for borrowed funds. Interest expense is a non-operating expense shown on the income statement. It represents interest payable on any borrowings—bonds, loans, convertible debt or lines of credit.
What is considered business interest expense? ›
Business interest expense is any interest expense that is properly allocable to a trade or business that is not an excepted trade or business. Floor plan financing interest expense is also business interest expense. See Q/A 8, above, for what is considered interest.
How much interest expense can you deduct? ›
You can deduct the mortgage interest you paid during the tax year on the first $750,000 of your mortgage debt for your primary home or a second home. If you are married filing separately, the limit drops to $375,000.
How do you calculate business interest? ›
Business interest expense is the amount you pay in interest on loans. It is fairly simple to calculate interest expense for a past year. You simply add up the interest charges from your creditors.
What happens to excess business interest expense? ›
To the extent a partnership's business interest deduction is limited, the deferred business interest (“excess business interest expense”) must be allocated to the partners, which reduces the partners' bases in their partnership interests.
How do you handle interest expense? ›
Calculating the interest expense can be done by multiplying the debt balance with the interest rate and time period. Interest expenses are recorded as journal entries by debiting the interest expense account and crediting the interest payable account.
What are examples of business interest? ›
Examples of Common Business Interests
- Charitable Organizations.
- Churches and Religious Organizations.
- Private Foundations.
- Political Organizations.
- Other Nonprofits. Lifecycle of an Exempt Organization. Requirements for Exemption. Application for recognition of exemption.
For example, a business borrows $1000 on September 1 and the interest rate is 4 percent per month on the loan balance. The interest expense for September will be $40 ($1000 x 4%). The business then pays $500 on the loan on October 1. The interest expense for October will be $20 (500 x 4%).
How do I report business interest expense? ›
Use Form 8990 to figure the amount of business interest expense you can deduct and the amount to carry forward to the next year. For more information, see Regulations sections 1.163(j)-1 through 1.163(j)-11.
Types of interest not deductible include personal interest, such as: Interest paid on a loan to purchase a car for personal use. Credit card and installment interest incurred for personal expenses.
Does interest expense reduce taxable income? ›
Investment interest expense
The amount that you can deduct is capped at your net taxable investment income for the year. Any leftover interest expense gets carried forward to the next year and can potentially be used to reduce your taxes in the future.
How does interest tax deduction work? ›
The mortgage interest deduction is a tax incentive for homeowners. This itemized deduction allows homeowners to subtract mortgage interest from their taxable income, lowering the amount of taxes they owe. Homeowners can also claim the deduction on loans for second homes providing that they stay within IRS limits.
What is the formula for interest expense? ›
The simple interest expense formula is Interest Expense = Principal x Rate x Time. r = The rate of interest expressed as a decimal. For example, 5% would be written as 0.05. As the name suggests, this can lead to relatively simple calculations for interest expenses.
What type of account is the interest expense? ›
Account Types
| Account | Type | Credit |
|---|
| INTEREST EXPENSE | Expense | Decrease |
| INTEREST INCOME | Revenue | Increase |
| INTEREST PAYABLE | Liability | Increase |
| INTEREST RECEIVABLE | Asset | Decrease |
90 more rowsInterest is found in the income statement, but can also be calculated using a debt schedule. The schedule outlines all the major pieces of debt a company has on its balance sheet, and the balances on each period opening (as shown above). This balance is multiplied by the debt's interest rate to find the expense.
