Welcome to Part 4 of our 2018 Small Business Guide to Lines of Credit. Today, we’ll answer some frequently asked questions about taxes and business lines of credit, particularly in light of the new U.S. tax laws.
Are you a small business owner thinking about applying for a business line of credit? Perhaps you already have one?
Wherever you are on your financing journey, it’s important to understand the tax implications of borrowing against a line of credit. For example, while a line of credit isn’t recognized as income for tax purposes (since the money you borrow is paid back), there are several tax write-offs and considerations to keep in mind.
In this part in our 2018 Small Business Guide to Lines of Credit, we’ll answer your biggest questions about taxes and business lines of credit, particularly in light of the 2017 Tax Cuts and Jobs Act. Of course, every business is different, so not all of these questions will apply to everyone. When in doubt, we recommend you consult your tax professional or accountant.
Can I deduct line of credit repayments on my taxes?
No. Any funds drawn against a business line of credit aren’t considered a cost to your business and are not eligible for a deduction.
What about the interest on a business line of credit?
Yes, you can deduct interest payments made on funds you borrow. To do this, you must prove that the deduction is both an “ordinary and necessary” business expense. According to the IRS: “An ordinary expense is one that is common and accepted in your trade or business. A necessary expense is one that is helpful and appropriate for your trade or business. An expense does not have to be indispensable to be considered necessary.”
Using a line of credit to purchase equipment or inventory, for example, would all fall into the category of an ordinary and necessary business expense.
Tip: We recommend keeping an itemized list of any assets you purchase with your line of credit. That way, you can maximize your deductions through the year, and you’ll have a paper trail in the event of an IRS audit.
How do depreciation deductions work and how might a line of credit affect these?
If you use your line of credit to purchase new equipment for your business, you may be able to take the bonus depreciation deduction on the equipment.
Most types of tangible property (except, land and inventory), such as buildings, machinery, vehicles, furniture, and equipment are depreciable. To be eligible, the asset must have a useful life of more than one year. The depreciation is then written off over the useful life of that asset. You can start depreciating once the asset is in use and stop once the cost is fully recovered or you no longer use it in your business. The bonus depreciation deduction is claimed as a business expense on Form 4562.
Talk to your tax advisor about claiming this deduction. With the passing of the Tax Cuts and Jobs Act of 2017 (TCJA), the bonus depreciation percentage has expanded from 50% to 100% and the assets that qualify for the deduction have also changed.
Tip: Keep a record of when you put any equipment or other assets into service so that you can accurately claim any bonus depreciation.
How can I maximize my tax position?
The best way to ensure you’re maximizing your deductions is to keep your personal and business finances separate. Maintain a separate bank account for any funds you borrow against your line of credit and use that account exclusively to make purchases or relay funds towards business expenses. Not only will this make recordkeeping easier, it will also help cover you if the IRS has any questions.
Another best practice is never to use your line of credit for personal expenses. This could result in the IRS reclassifying your line of credit as personal, and refute your ability to claim any business expense deductions associated with it.
How should I stay on top of recent changes to the tax law?
Unless you are a tax expert yourself, the best way is to consult with a trusted tax advisor. Although the tax preparation deduction has been eliminated by the TCJA, it’s important to get expert advice. We’ve mentioned a few changes here, but there may be more that apply to your specific situation.
During tax season, and year round, your tax advisor can help ensure you’re up to date on changes to tax law, keep you in compliance, and help you get the deductions you deserve.
We hope you found the Fundbox 2018 Guide to Business Lines of Credit helpful!
Be sure to check out the other parts in the series:
Disclaimer: The information in this blog doesn’t replace the advice of a tax or legal expert. Fundbox and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction. If you have any questions about your small business tax situation, talk to a professional.