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 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 reimbursement on the corporate return.

The Internal Revenue Service (IRS) has laid out guidance on business interest expense limitations in Notice 2018-28.

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.