| Not all interest is deductible by a business. In general, you are not permitted to deduct interest that must be capitalized under the Internal Revenue Code, that is not really interest, that is personal interest, or that is prohibited under other sections of the tax law.
Interest Paid with Funds Borrowed from an Original Lender
If you take out a second loan from a lender and use the proceeds to pay the interest on a first loan from the same lender, you are not allowed to deduct the interest on the first loan if you use the cash method of accounting. You will, however, be able to deduct the interest expense once you begin making payments on the second loan.
Capitalized Interest
Under the uniform capitalization rules, you are required to capitalize interest on debt equal to your expenditures to produce real property or certain tangible personal property for use in your trade or business or for sale to customers. In addition, you may not deduct the interest on any debt you assumed from a seller of property. This interest will increase the basis of the property.
Commitment Fees or Standby Charges
Fees incurred in order to have business funds available on a standby basis are not deductible as interest payments. However, they may be deductible as business expenses. If the funds are commitment fees for inventory or certain other property used in your business, they are indirect costs that must be capitalized and not deducted as interest.
Interest and Penalties on Income Tax
If the Internal Revenue Service assessed interest on your individual income tax return, you are not entitled to deduct the interest as a business deduction even if the tax due is related to income from your trade or business. Penalties on unpaid income tax and estimates are also not deductible.
Interest on Loans with Respect to Life Insurance Policies
Generally, the tax law does not allow you to deduct interest on a debt incurred with respect to any life insurance, annuity, or endowment contract that covers any individual unless that individual is a key person. A key person is an officer or a 20 percent owner of a business; however, the number of key persons in any business is limited by statute.
If the policy is on a key person, you are permitted to deduct the interest up to $50,000 of debt for that person, with certain limitations.
There are a few exceptions to the general rule of non-deductibility of interest on loans with respect to life insurance policies. If the contract was issued before June 1997 and the covered individual is someone other than an employee, officer, or someone financially interested in the business, the interest is deductible. If the contract was purchased before June 21, 1986, the interest is deductible no matter who is covered by it.
Generally, corporations and partnerships cannot deduct any interest expense allocated to unborrowed cash values of life insurance, annuity, or endowment contracts if the contract was issued after June 8, 1997, and it covers someone other than an employee, officer, or a 20 percent owner. Copyright 2010 LexisNexis, a division of Reed Elsevier Inc. |