 Income tax 2022-2023, business expenses, interest. Let's do some wealth preservation with some tax preparation. Most of this information comes from the Tax Guide for Small Business for Individuals Who Use Schedule C, Publication 334 Tax Year 2022. You can find on the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused online on income. Remember, in the first half of the income tax formula is in essence an income statement, but just an outline of other forms and schedules flowing into these line items. One of those, the Schedule C, having business income minus business expenses, the net business income flowing in from the Schedule C to line one income of our income tax formula. On the Form 1040, remember that the Schedule C flows into the Schedule 1. We support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Which flows into page one of the Form 1040 line number eight. The Schedule C is the profit or loss from business has an income statement format. Income minus expenses were focused on the expense side of things here. In particular, the interest expense. All right, so let's dig into it. Interests, you can generally deduct as a business expense, some or all interests you pay or accrue during the tax year on debts related to your business. Now note that interest gets a little bit confusing because it's changed over the year in terms of some of the personal kind of interests that's been deductible. And you also have some interest that's still deductible that's a little bit different than a business expense like the home mortgage interest for example. So in other words, you would expect that interest would be something that would be deductible if it's business related interest. So for example, if you're starting to schedule C type of business, business, home, white business. And you need to buy equipment in order to start the business. Oftentimes you have to finance the purchase of the equipment taken a loan out to purchase the equipment. And because you took the loan out for the equipment that's being used on the business, you would expect the rent on the purchasing power that being the interest to be a deductible item. So that general scenario, you would expect that to be an ordinary and necessary business expense of financing the business. The reason it gets a little bit confusing is because you might also think, well wait a sec, like mortgage interest is deductible and mortgage interest is deductible on the schedule A and it has to do with a personal item. So why is that deductible? Don't know. It's a weird situation because they decided they wanted to stimulate the housing market or something like that. So they allowed the mortgage interest to be deductible. So that's kind of an outlier, strange situation. But you can also have a situation where you use part of your home out for a business office or something like that. So now you've got an interest on the mortgage which partially is for the business use. And so the question is, do I get to deduct possibly part of the interest of a home office? So you might have to break out the interest in that situation between business versus personal. And you can look into the home office for more there. And then you can also have situations where the business loan, you take out a loan which might have a partial business and a partial personal use. And that could also kind of complicate things because you generally want to break those two things out to business and personal because the business side is deductible. But sometimes the bank isn't so concerned with what's deductible or not. So you want to have collateral. So you might be able to get a loan that's going to be collateralized by something. And then the purpose of the loan might be for business or personal. And then you'd have to be breaking out between the business and personal. One more kind of situation that's a little bit confusing is that you might take out a business loan and use something that's collateral that is personal in nature. Like the home is what the bank is usually going to be looking for. So if you don't pay the loan, the home is collateral. That's more secure kind of collateral. But you took out the loan not to make an improvement to the home or something like that. But you used it for a business loan or something like that, which is again a little bit of a weird situation because now you needed the financing for the business. The bank wanted something as collateral that could be personal. So that's where these things get a little bit muddy. But the general rule, if you took out the loan to finance the purchase of equipment or something like that for the business, you would expect the rent on the purchasing power of the money, the interest to be deductible. All right, interest relates to your business. If you use the proceeds of the loan for a business expense, it does not matter what type of property secures the loan. So securing the loan, meaning if you don't pay the loan, the bank comes after it. Is it your home? Is it your car? Is it your equipment? So notice what they say that it doesn't matter what the type of property secures it because what matters is what you use the funds on. Did you use the funds for business to buy like equipment or something like that? Or did you use it for something personal to go on vacation or whatever? So you can deduct interest on a debt only if you meet all of the following requirements. You are legally liable for the debt. So you have to pay the debt back. Both of you and the lender intend that the debt be repaid. So clearly, if one doesn't intend for the debt to be repaid, it's not really a debt. It's more of like a gift or something. So you and the lender have a true debtor-creditor relationship, which would indicate the first two would indicate kind of the third. You're a debtor-creditor. You're not having a gift or some kind of family money transfer or something like that that's not debt. So certain taxpayers are required to limit their business interest expense deduction. See the instructions for form 8-9-9-0 to determine whether you are required to limit your business interest expense deduction, who is required to file form 8-9-9-0 and how certain businesses may elect out of the business interest expense limitation. You cannot deduct on schedule see the interest you paid on personal loans. That's the big key here, right? Obviously, if you took the loan out and you used it to go on vacation, you can't deduct it on the schedule see unless you went to the Bahamas because you're a photographer or something like that. And they took the loan out for that reason, which lucky, lucky you. I wish I was, but whatever. So if a loan is part of business and part personal, you must divide the interest between personal part and the business part. That's when it gets messy. If you got a loan and you used it partially business, partially personal, then you need to only be able to deduct the portion of the interest that is personal. Example, so in 2022 you paid $600 interest on a car loan. During 2022, you used the car 60% for business and 40% for personal. So now you've got this car loan, but you use it 60-40 business personal. So now you've got the interest related to it. So you can only deduct $360, which is 60% of the $600 for 2022 on the schedule see. The remaining interest of $240 is non-deductible because it's personal expense. So more information. For more information about deducting interest, see chapter 4 of publication 535. That chapter, you can find that on the IRS website, of course. That chapter explains the following items. Interest you can deduct. Interest you cannot deduct. How to allocate interest between personal and business. So if you have questions that go into more detail in terms of is this a deductible item or not possibly because it's a more complex kind of situation in terms of the loan, you can go into that publication or if you need more instruction in terms of how to deduct. If you need more instruction in terms of how to allocate the interest between personal and business, you might have a more complicated situation there. You can take a look at the publication. Limitation on business interest. I went to deduct interest. So, you know, obviously you could have an accrual versus the cashed based system. So usually we kind of pay interest. If it's an installment loan, that's what we're most familiar with. So we pay back on a monthly basis. But you can imagine loan structures. If it's a business loan to be structured in other ways. And then the question is, well, if I accrued interest and have not yet paid it, what time period should I be deducting the interest when I incurred the interest or when I paid it for similar thing to like rent, right? If I had my office building that I rented the office building, usually I paid the rent monthly, but I could imagine other situations of the rent where I incurred the use of the office building but came to some kind of agreement that I'm going to pay them later. Well, then the question is, when do I get the expense when I incurred it or when I paid it kind of situations? Okay, so the rules for a below market interest rate loan. So this is generally a loan on which no interest is charged or on which interest is charged as a rate below the applicable federal rate. Now this is an interesting situation because you might encounter situations where you have a loan but no interest rate was calculated on it for whatever reason. Maybe it was structured like as a lease or something, but it's actually a loan like a purchase versus a lease kind of situation or you had a loan between like a sometimes low period loans that are for shorter time frames. Try to like don't calculate the interest they kind of imputed into the payments and loans between family members sometimes or something like that where you might have situations where you don't calculate the interest but the idea would be that if you structure the loan without interest being charged on the loan then it's not like no interest is being charged. What really happens is that you have imputed the charge of interest in the loan. So for example if you were a financial and you're going to loan someone money let's say you're going to loan someone $10,000 or something for five years or something like that well then you're not just going to give them $10,000 and then say you just pay it back to me in five years because even if you totally trusted them to pay you back in five years then the $10,000 you're going to get back in five years is going to be worth far less than the $10,000 you have now due to inflation and the fact that you could have used it today to earn money you could have invested it and earned money on it. So that doesn't usually happen unless it's like a family member or something like that that you're given a loan to because you're not going to actually get the fair market value even of the money back from the loan little loan making money on the loan. So you would expect then that there would be so you would expect that if a situation was set up so no interest was involved that if it was an arms length transaction the interest was actually imputed in the amount of payments that are going to be taking place so then you have to go in and kind of impute and think about what would be the appropriate market interest rate for this particular loan which can get a little bit messy.