Rules for expensing interest
As your company's or client's financial statements and tax returns are being prepared, questions may arise about interest expense. What is deductible and what is not-from loans on life insurance to commitment fees for lines of credit? Here is an update we recently gave in The General Ledger newsletter(www.aipb.org/general_ledger.html), the free monthly briefing for members. As a member, you have access to valuable information like this from prior issues at the AIPB Web site on the "Members Only" page.
The rules are as follows:
- Insurance contracts. Owners who borrow on their life insurance, endowment or annuity contracts and use the proceeds for business purposes can take a business deduction for interest paid. For loans on insurance covering an officer, employee or individual financially interested in the trade or business, the interest deduction is limited to loans of $50,000 or less.
- Mortgages. If the proceeds of the mortgage are used for business activities, the interest portion of the mortgage payment may be deducted. If the mortgage is paid off early and a penalty is paid for early repayment, the penalty is deductible as interest expense.
- Points. These loan origination fees are interest paid in advance and there-fore are expensed pro-rata over the life of the loan.
- Mortgage-related costs, such as commissions, abstract fees and recording fees, are amortized over the life of the loan and should not be deducted as interest in the year incurred. Note: Mortgage-related costs are added to cost basis only for home mortgages, not for commercial ones.
- Commitment fees and standby charges (payments made to make funds available to the business on a standby basis, such as interest on unused funds for a line of credit from a bank). When the loan privilege is exercised (when the business actually borrows the money), the interest is deducted over the life of the loan. If the loan is not taken and the right to borrow expires, the commitment fee is taken as an expense in the year that the right to the loan expired.
- Interest and penalties on income taxes owed are not deductible by the business.
This is one example of the practical help you get free as a member. Join now and let the February General Ledger (www.aipb.org/general_ledger.html) show you:
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