Deducting Merchant Cash Advance Fees and Interest on Your Taxes

Deducting Merchant Cash Advance Fees and Interest on Your Taxes

Merchant cash advances (MCAs) have become an increasingly popular form of financing for small businesses in recent years. Unlike traditional bank loans, MCAs provide quick access to capital without requiring strong credit scores or collateral. However, MCAs come at a high cost, with factor rates and fees typically ranging from 1.1 to 1.5 times the amount advanced.

As a business owner, you may be wondering if you can deduct MCA fees and interest on your taxes to help offset some of these costs. The answer is not completely straightforward. While MCAs are not considered loans in the legal sense, some of the costs associated with them may still be deductible as ordinary business expenses.

The Difference Between MCAs and Business Loans

To understand the tax implications of merchant cash advances, it helps to first understand how they differ from regular business loans.

With a traditional term loan or line of credit, a lender provides you with a principal amount upfront, which you then pay back over time with interest. The interest rate is usually a fixed annual percentage rate, such as 5% or 10% APR.

MCAs work differently. Rather than charging interest, MCA providers charge a factor rate as a fee for advancing you capital. This factor rate is expressed as a multiplier of the total amount advanced – often between 1.1 and 1.5.

For example, if you receive a $10,000 MCA with a factor rate of 1.3, you would owe $13,000 back to the provider. The $3,000 difference represents the fee for obtaining the capital.

Unlike with a loan, you don’t make fixed monthly payments on an MCA. Instead, the provider takes a percentage of your daily credit card sales until the full amount is repaid.

The Tax Treatment of MCA Fees

Given these differences, you may be wondering if you can deduct MCA fees on your taxes like you would interest on a business loan.

Unfortunately, the answer is generally no. According to the IRS, you cannot deduct the entire cost of an MCA as interest, since MCAs are not technically loans[1].

However, that doesn’t mean you get no tax benefit at all. Even though MCA fees aren’t interest, some portion of them may still be deductible as ordinary business expenses.

The key is determining what part of your MCA repayments reflect deductible fees versus repayment of the original capital amount (which is nondeductible). This requires calculating the implied daily rate based on the total fees charged across the term of the MCA.

Let’s go back to our earlier example of a $10,000 MCA with a 1.3 factor rate. The $3,000 in total fees works out to an implied daily rate of about 0.82% ($3,000 ÷ $10,000 ÷ the number of days to repay).

Each day, 0.82% of your repayment would represent fees while the remainder goes toward the original $10,000 you were advanced. It’s the 0.82% daily fee portion that may be deductible.

This can get complicated quickly, so it’s a good idea to work with a tax professional to determine the amount of deductible fees in your MCA payments. Maintaining thorough documentation is also critical.

Claiming the MCA Fee Deduction

To claim your deductible MCA fees, you report them as an ordinary business expense on your tax return.

If you are a sole proprietor filing Schedule C, you would list the fees under Other Expenses. For an S-corp or partnership, deduct them on the appropriate business income tax return and flow the deduction through to your personal return.

The IRS may require you to prove that the amount you deducted represents legitimate fees rather than repayment of principal. That’s why keeping detailed records of your MCA agreements and payments is so important.

You face limitations on how much of the fees you can deduct each year. MCA fee deductions are subject to the normal cap on business interest expenses under section 163(j) of the tax code. This limit is 30% of adjusted taxable income for most taxpayers[2].

Any nondeductible fees can be carried forward to future tax years until the full amount is deducted (subject to the cap).

Other Potentially Deductible MCA Costs

Beyond factor rate fees, you may also be able to deduct other costs associated with obtaining an MCA. These could include:

  • Origination fees – Upfront fees charged by the MCA provider to process your application.
  • Legal fees – Fees paid to an attorney for assistance in reviewing and negotiating your MCA agreement.
  • Repayment processing fees – Fees deducted from your daily credit card receipts by the MCA provider to process your repayments.
  • Late fees – Fees charged by the MCA provider if you are late on any payments.

These types of costs are deductible as ordinary business expenses in the year they are incurred. You would report them on your tax return under the same categories mentioned earlier.

The Importance of Tracking Expenses

If you want to maximize your MCA tax deductions, meticulous record-keeping is a must. You should retain copies of:

  • Your original MCA agreement showing the total amount advanced and fees charged.
  • Receipts and bank statements showing any upfront costs you paid.
  • Daily or weekly payment statements from the MCA provider.
  • Canceled checks or bank statements proving repayment of any fees.

With this documentation, you can prove to the IRS precisely which portions of your MCA payments represented deductible fees versus nondeductible repayments of principal.

Claiming Other Business Tax Deductions

Besides potential MCA fee deductions, don’t forget about other valuable tax write-offs for small businesses:

  • Equipment purchases – The cost of computers, machinery, vehicles, and other equipment used for business purposes is deductible under section 179 up to certain limits[3].
  • Office rent and utilities – If you lease commercial space for your business, the rent and utility costs are deductible.
  • Employee expenses – The cost of wages, benefits, payroll taxes, and certain other employee-related expenses are deductible as ordinary business expenses.
  • Advertising costs – Any amount you spend on advertising and marketing for your business is fully deductible.
  • Start-up costs – Up to $5,000 in business start-up costs may be deducted in the first year. Any excess must be amortized.
  • Mileage and transportation – Mileage driven for business purposes in your personal vehicle is deductible at the current standard mileage rate (58.5 cents per mile for 2023).

Don’t leave money on the table by missing out on available business expense deductions. Consult a tax professional to identify all deductible costs.

The Bottom Line

While you cannot deduct an MCA as you would a loan, some portion of the fees may qualify as tax-deductible business expenses. Work closely with your tax advisor to calculate the deductible amount and make sure you have thorough records.

With proper documentation and tax planning, merchant cash advances can still provide a net financial benefit despite their high costs. Just be sure to factor the tax savings into your overall analysis when deciding if an MCA makes sense for your business.