Business Interest Expense - Explained
What is a Business Interest Expense?
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Table of ContentsWhat is a Business Interest Expense?How to Account for Business Interest Expenses?Business Interest Expense vs. DeductionsBusiness Interest Expense exemption for Small BusinessAcademic Research on Business Interest Expense
What is a Business Interest Expense?
Business interest expense refers to the interest cost imposed on business loans for maintaining operations. The business interest expenses may be deducted as an ordinary business expense for particular businesses. To be able to deduct a loan interest, you must have used the loan to pay for the business expense or purchase business assets. However, where you use the loan for purposes not related to business, then the amount of interest subject to deduction must be proportionally reduced.
How to Account for Business Interest Expenses?
It is important to ensure that you deduct business expenses on proper tax forms. The forms should correlate with the business for which the expenditure was made. Taxpayers who incur corporate business expenses cannot deduct these on their personal returns. Instead, the businesses should reimburse the taxpayers and then deduct the reimbursement on their corporate return.
Business Interest Expense vs. Deductions
In 2017, there was a passage of Tax Cuts and Jobs Act in the United States that provided several provisions that reduce the businesses tax burden. The most important changes included the following:
- 35 to 21 percent corporate tax cut
- New deduction of 20% for qualified business income.
To be able to offset those reductions, there was a limitation placed by Congress on the amount of interest deductible for various types of businesses. Also, following these deductions, taxpayers in 2018 were in a position to deduct business interest with a number of rare exceptions. Following Job Acts and Tax Cuts changes, there are now net business interest deductions that are limited to 30% of adjusted taxable income of the taxpayers. The deduction limit on taxable income does not put into consideration the following:
- Business interest expenses and income
- Net operating losses
- Non-business income
- Depletion or amortization
Note that this limitation is not applicable to interest generated from investments. The deduction for things like amortization, depreciation, or depletion is applicable only up to 2021. It means that in 2022, businesses with intensive capital should expect higher tax bills.
Business Interest Expense exemption for Small Business
As aforementioned, the deduction limitation is no application to things like small businesses, real estate investment companies, farms, and particular utilities. A small business, in this case, falls under a category of companies with an average annual gross of $25 million or below over a three year period. The purpose of the three-year look-back is to make sure that companies are not broken to come below the stated $25 million thresholds.