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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.
A Little More on What is a Business Interest Expense
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.
Reference for “Business Interest Expense”
Academic research on “Business Interest Expense”
First Look at the Tax Cuts and Jobs Act of 2017: Seven Questions about the Business Interest Expense Deduction, Simms, K., Smith, J., & Moreschi, R. (2018). First Look at the Tax Cuts and Jobs Act of 2017: Seven Questions about the Business Interest Expense Deduction. The CPA Journal, 88(7), 22-24.
The Deductibility of Interest Expense in Anglo-American Countries: A Comparison and Review of Policy, Richardson, G., & Devos, K. (1999). The Deductibility of Interest Expense in Anglo-American Countries: A Comparison and Review of Policy. Revenue Law Journal, 9(1), 6617. The deductibility of interest expense has been one of the most controversial issues in taxation law over the past decade, which raises the issue of modification. The purpose of this article is twofold. Firstly, to broadly analyse and compare the laws of a number of Anglo-American countries including Australia, Canada, New Zealand, the United Kingdom and the United States of America, which govern the deductibility of interest. Secondly, to review certain taxation policy arguments for either restricting or denying a deduction for interest in those Anglo-American countries. The study revealed that no coherent general principle of application in the area of the deductibility of interest was achievable in taxation law. Furthermore, a review of taxation policy in this area also revealed that interest incurred on borrowings of a private purpose represented the only restriction that should be placed on interest deductibility. Therefore, a general statutory approach may be the best solution to achieving this result.
Cost of external finance and selection into entrepreneurship, Nanda, R. (2008). Cost of external finance and selection into entrepreneurship. Harvard Business School Entrepreneurial Management Working Paper, (08-047). This paper examines the extent to which the positive relationship between personal wealth and entry into entrepreneurship is due to financing constraints. I exploit a tax reform and use unique micro-data from Denmark to study how exogenous changes in the cost of external finance shape both the probability of entering entrepreneurship and the characteristics of those who become entrepreneurs. As expected, differences-in-differences estimates show that the entry rates for individuals who faced an increase in the cost of finance fell by 40% relative to those whose cost of external finance was unchanged. However, while some of the fall in entry was due to less wealthy individuals with high human capital (confirming the presence of financing constraints), the greatest relative decline in entry came from individuals with lower human capital, many of whom were above median wealth. This finding suggests that an important part of the positive relationship between personal wealth and entrepreneurship may be driven by the fact that wealthy individuals with lower ability can start new businesses because they are less likely to face the disciplining effect of external finance.
Leasing versus borrowing: Evaluating alternative forms of consumer credit, Nunnally Jr, B. H., & Plath, D. A. (1989). Leasing versus borrowing: Evaluating alternative forms of consumer credit. Journal of Consumer Affairs, 23(2), 383-392. A straightforward method for evaluating lease versus borrow (buy) decisions facing consumers is presented and illustrated with actual financing cost data reported to new car purchasers. In general, individuals should consider the after‐tax cash flows associated with alternative borrowing arrangements, the period of time in which these cash flows occur, and the opportunity cost of capital in order to identify the least costly financing alternative. The decision framework provided in this article can be used to make informed and intelligent choices between alternative types of consumer credit contracts.
US: The Impact of the California Unitary Business Concept on the Taxation of Multinational Corporations, PETERSEN, E., & WALSH, F. (1978). US: The Impact of the California Unitary Business Concept on the Taxation of Multinational Corporations. Intertax, 107.
Fair Market Value Interest Expense Apportionment, Conlon, R., & Smith, L. (1999). Fair Market Value Interest Expense Apportionment. Corp. Bus. Tax’n Monthly, 1, 3.
Income and Expense Rules After Tax Reform: Helping Clients Cope, Korb, P. J., Martin Jr, C. L., & Stewart, B. R. (1987). Income and Expense Rules After Tax Reform: Helping Clients Cope. Journal of Accountancy, 164(3), 126.
The Dividend and Interest Exclusions: A Changing Scene, Smith, J. E. (1982). The Dividend and Interest Exclusions: A Changing Scene. Taxes, 60, 240.
US: Allocation of Deductions to income from International Operations I1, Walsh, F. J. (1978). US: Allocation of Deductions to income from International Operations I1. Intertax, 6, 4.