What expense category is Bank Loan Payments?

Taking out a bank loan is a standard step for many businesses to finance operations, purchase assets, or manage cash flow. While making regular loan payments is a routine part of financial management, a frequent and significant tax error is to assume the entire payment is a deductible business expense.

The IRS has very clear rules: a loan payment consists of two distinct parts—principal and interest—and only the interest portion is deductible. This guide explains how to categorize your loan payments correctly to ensure compliance and maximize your deductions.

Bank Loan Payments Category

A bank loan payment must be broken down into its two components, as each has a completely different accounting and tax treatment.

1. Principal Repayment (Not an Expense): The principal portion of your payment is the return of the money you borrowed. This is not a deductible expense. Instead, it is a reduction of a liability on your company's balance sheet.
2. Interest Paid (A Deductible Expense): The interest portion of your payment is the cost of using the borrowed funds. IRS Publication 535 states that you can generally deduct interest paid on debts related to your business. This is reported as Interest Expense.

Important Considerations While Classifying Bank Loan Payments

Correctly separating principal from interest is the most critical step in handling loan payments.

Principal Repayments Are Never Deductible

The repayment of the loan principal is simply returning money that was never counted as income when you received it. Therefore, it cannot be deducted as an expense when you repay it. Your loan statement from the bank will clearly show how each payment is split between principal and interest.

Allocation Between Business and Personal Use

If you use the proceeds of a loan for more than one purpose, you must allocate the interest based on the specific use of the funds. Publication 535 is clear: if you use 70% of a loan for business purposes and 30% for personal expenses, you can only deduct 70% of the interest paid as a business expense.

Interest on a Loan to Pay Taxes

Publication 535 also specifies that you cannot deduct interest on a loan you took out to pay federal income taxes. This is not considered a business expense.

Tax Implications and Recordkeeping

Only the business portion of the interest you pay is deductible.

How to Report the Deduction

For a sole proprietor filing a Schedule C (Form 1040), the deductible interest portion of your loan payments is reported on Part II, Line 16, Interest. Do not include the principal repayment amount in this section.

Business Interest Expense Limitation

Your deduction for business interest may be limited. Certain businesses are required to file Form 8990 to calculate the limit on their business interest expense deduction for the year.

What Records to Keep

You must keep detailed records that separate principal and interest payments. Your essential documents include:

• The original loan agreement.
• Monthly or periodic loan statements from the bank that clearly break down each payment.
• Proof of payment, such as canceled checks or bank statements.

How Fyle Can Automate Tracking for Loan Payments

While Fyle doesn't manage loan amortization, it provides a robust system to document every payment and related file for accurate accounting and compliance.

• Centralize Loan Documents: Attach the original loan agreement and any related correspondence directly to an expense record in Fyle.
• Track Every Payment: Capture each loan payment to create a complete and unalterable record of your payment history.
• Create a Clear Audit Trail: Fyle keeps loan statements and payment proofs organized and easily accessible for your accountant.
• Automate Your Accounting: Fyle syncs payment data to your accounting software, such as QuickBooks, Xero, or NetSuite, making it easy for your accountant to record transactions and correctly split deductible interest from the principal.