Business loans are used by many companies to grow their enterprises. As loan standards remain stringent, companies are starting to look elsewhere for much-needed capital. Companies that find funding are often unaware of potentially costly tax liabilities.
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Knowledge is the first best defense that a business owner can possess in order to avoid tax liabilities. Numerous factors such as the tax filing status of a business, the state of incorporation and even the documentation in a loan can have wide-ranging implications.
There are numerous tax deductions available to businesses that also help mitigate any tax liabilities. These deductions, which range from automobile to legal and accounting expenses, can help mitigate the tax liability of a business.
Companies can not only utilize business loans to grow their business but also can also use these loans to save money on taxes. The first and most obvious way to do this is to deduct the interest paid on business loans. Although the Internal Revenue Service (IRS) does not allow for the deduction of interest on personal credit lines, they do allow for a deduction on business credit lines.
Sometimes a company may receive a loan at favorable terms compared to other similar offers. This is referred to as a “below-market loan." These loans may charge no interest or may charge interest at a rate below prevailing rates. But there is a catch to these types of loans: if certain tax conditions are not met, the loan can be treated as a gift or as ordinary income, which could possibly increase a company’s tax liability.
Consideration should also be shown toward accrued wages and bonuses. Companies should take the steps to establish payment arrangements in order to avoid being subject to penalties under Internal Revenue Code Section 409A. It’s important for business owners to pay close attention to independent contractors and how their responsibilities differ from that of regular employees, as this is fast becoming a catalyst for IRS audits.
Companies must also be aware of the consequences of paying off debt, especially to shareholders. For example, some S Corp (also known as "S Corporation") shareholders will make cash advances to the corporation during years when the company is in trouble. The corporation will eventually repay these infusions when operating conditions are more favorable. However, if the company treats the infusion as debt and the shareholder utilizes the debt basis to claim further flow-through losses, any loan repayment could expose the shareholder to capital gain tax or even ordinary income tax.
Should the need become apparent, a tax attorney or accountant must be consulted if there is confusion regarding these guidelines. As tax codes (and tax situations) frequently change, it should go without saying that any subsequent response should change accordingly.