There are instances when you can write off interest on personal loans used for your small business. Just keep in mind that interest expenses must be classified into one of four categories: business, passive, investment or personal. Different tax rules apply to each type of interest. Read our post on the interest categories for more information.

Loans to Inject Capital into an S Corp, Multi-Member LLC or Partnership

If you use loan proceeds for an S corporation, a multi-member LLC, or a partnership, the issue becomes how to treat the resulting interest expense on your tax return.

According to the IRS, you can allocate the loan proceeds using any reasonable method. Once the proceeds have been properly placed into the business, passive, or investment categories, you allocate the interest expense in the same proportions. An acceptable method includes allocating the debt to the various types of assets owned by the entity. These write-offs reduce your income and self-employment tax bills. They also lower your adjusted gross income, which means you might qualify for various tax breaks.

Loans to Inject Capital into a C Corp

When you borrow to inject capital into a C corporation, the related interest expense falls into the investment interest category, no matter how active you are in the business, or how you use the borrowed funds.

Your ability to deduct the investment interest expense depends on how much investment income you generate. For this reason, you may be better off making a back-to-back loan to your C corporation and charging interest at least equal to what you pay the lender.Then you will be able to deduct the interest expense, thanks to the investment income generated by the corporation’s interest payments to you. At the corporate level, your company gets a deduction for the interest it pays you. Everyone comes out ahead.

As you can see, getting the best tax results for interest expenses can be complicated. Consult with your Filler & Associates about maximizing deductions.