Using Business Debt to Reduce Your Tax Bill
Taking on debt for your business can be a smart financial move, allowing you to invest in growth while potentially reducing your tax burden. Here’s a guide on how business debt works and how it can lower your taxes.
How Business Debt Reduces Taxes
When you take out a business loan or use a credit line, you are not taxed on those funds. However, you can use that debt to make purchases for your business that are tax deductible, essentially letting you deduct expenses you did not directly pay for. This can significantly lower your taxable income and what you ultimately owe in taxes.
Some common examples include:
- Taking out a small business loan to purchase equipment like computers, machinery, or vehicles. You can deduct that equipment over time through depreciation deductions.
- Using a business credit card to pay for travel, meals, entertainment, marketing, software, supplies, etc. These are deductible business expenses.
- Financing new real estate for your business with a commercial mortgage. You can deduct mortgage interest and depreciate the building.
As you can see, by using debt instead of your own cash reserves, you gain tax deductions without an offsetting taxable event like drawing income or selling assets. This lets you reinvest in your business at a lower after-tax cost.
Tax Deductions from Business Debt
Several major tax deductions stem from business debt, loans, and financing. Common write-offs include:
Interest Payments
The interest portion of loan payments, such as on a small business loan, line of credit, or commercial mortgage, is fully tax deductible in the year paid. This deduction applies to interest on up to $1 million of debt used for business purchases.
Depreciation
Assets like equipment, machinery, furniture, vehicles, and buildings decline in value over time. You can deduct that loss in value annually as a depreciation deduction. Taking on debt to finance these major purchases increases your depreciation write-offs.
Operating Expenses
Any normal operating expenses like inventory, marketing, R&D, maintenance, repairs, utilities, and supplies are deductible in the year paid. Putting these on credit cards or lines of credit allows you to deduct them even if you haven’t directly paid back the debt yet.
Start Up Costs
Starting a new business venture also comes with tax deductions for organizational and start up costs like legal fees for forming an entity, branding, market research, etc. These can be financed through debt as well.
Tax Strategy Tips
If your goal is to maximize deductions and minimize taxes through the strategic use of business debt, keep these tips in mind:
- Don’t over leverage. Taking on too much debt can put your business at risk, so be responsible with payment amounts and terms.
- Think long-term. Financing assets like equipment, vehicles, and real estate can secure deductions for many years through depreciation.
- Review financing options. Compare loans, credit cards, credit lines, and other products to find the best terms and rates for your business.
- Deduct interest first. Pay down highest interest debt first to maximize valuable interest deductions.
- Reinvest savings. Put the tax dollars you save back into growing your business.
Pitfalls to Avoid
While using debt can reduce taxes for your business, there are a few potential downsides to be aware of:
- Taking on excessive debt that puts your business at financial risk
- Paying high interest rates that offset the value of tax deductions
- Not having adequate revenue and cash flow to service debt payments
- Facing limitations on amount of deductions available each year
- Losing deductions if debt is not used for legitimate business purposes
As long as you borrow responsibly and put the funds to productive business use, you can unlock major tax reduction benefits from business debt. But work closely with both a tax professional and financial advisor to do it strategically and safely.
Professional Guidance Recommended
Navigating business taxes, debt, deductions, and regulations can get extremely complicated. It’s highly advisable to work with both a small business CPA and financial advisor to create a customized tax minimization strategy using debt. They can help you determine appropriate debt levels, best uses for funds, and how to maximize available deductions.
The Bottom Line
Taking on business debt allows you to access capital for growth investments while generating tax deductions that minimize owed taxes. Interest, depreciation, operating expenses, and other deductions effectively let you deduct expenses you haven’t yet paid for. This can greatly reduce your tax burden. Just be sure to borrow responsibly and strategically for your business. With professional guidance, you can use debt to drive growth today while reducing taxes for years to come.