Attention all small business owners: do you have short-term debt that was written off? And was it written off correctly?
If not, it might affect your chance of getting that next business loan. Here’s what you need to know, including what you shouldn’t do when writing off short-term debt.
What is Short-Term Debt?
Before you do anything, it’s important to understand what short-term debt actually is.
Short-term debt is any of your business debt due within the year, often including bank loans, credit cards, or credit lines. It’s listed in the liabilities section of your balance sheet.
Short-term debt can also include the portion of longer-term debt due within the year. For example, say you have a loan with a 5-year term. The payments due this year will be included with your short-term debt.
The interest portion of your short-term debt payments is generally a business expense—and a tax write-off, because it’s a cost used to grow your business. This means that it could be used to offset your business earnings, reducing your taxable business income.
Why It’s Important to Write It Off Correctly
Writing short-term debt off correctly could make the difference between an approval and a decline on your next business loan. When a loan officer reviews your tax returns and sees negative income, they might get a little concerned.
“While I’m not an accountant, I have seen quite a few tax returns where the interest expense clearly wasn’t written off properly—and this affected the borrower’s chances of securing a loan,” says Kate Morgan, Senior Loan Specialist at Fundera. “Small business owners come to us frequently to refinance their short term loans and graduate to more termed-out loan products, like medium-term or SBA loans,” she says.”These lenders have a tighter credit box, and in many cases require profitability.”
Many times, businesses that are actually profitable don’t show profitability on their tax returns due to write-offs, alongside other reasons. Some of these longer-term lenders will do what’s called “add-backs” to see if adding back certain write-offs will bring their numbers to profitability.
But if your short-term debt isn’t written off correctly, it might not get added back—diminishing your chances of securing that longer term loan.
The Top 4 Mistakes of Writing Off Short-Term Debt
If you’re planning to apply for a loan in the near future, here’s what not to do when writing off short-term debt.
1. Claiming Short-Term Interest Expense As a Bank Fee
Don’t do it! Bank fees might include monthly bank account fees, application fees, check printing, and processing fees, but they don’t include your short-term interest expenses. These should be recorded separately.
2. Claiming Short-Term Interest As a Credit Card Fee
While your credit card debt does fall into the short-term debt category, the interest paid should be accounted for separately from those annual credit card fees.
While lenders might add back short-term interest to cash flow as long as it’s claimed correctly, they won’t add back bank fees or credit card fees.
3. Not Including Interest Expense
Yup, it happens—and when interest expenses aren’t written off against your business income, your business might wind up paying more taxes than it should. “In the past, I’ve seen interest expenses left off of tax returns, which can greatly affect a small business owner’s tax liability at the end of the year,” says Morgan.
“In the past, I’ve seen interest expenses left off of tax returns, which can greatly affect a small business owner’s tax liability at the end of the year,” says Morgan.
4. Claiming Bad Debt As Short-Term Debt
For tax purposes, a business’s bad debt is a loss if you can’t collect money owed to you, according to the IRS. And while it might qualify as a tax write-off, it’s not a short-term debt write off. Check out the IRS Publication 135 for more information, if you’re interested.
Made a Mistake When Writing Off Short-Term Debt? Here’s What To Do
If you’ve already made a mistake when writing off short-term debt, there are a couple of things you can still do.
First, you might want to talk to a business accountant about re-filing your tax return.
Secondly, if the mistake resulted in a zero or negative net income tax return and you’re in the market for a business loan, pull out all of your supporting business documents and financial statements for your lender to review.
“If net income on tax returns is negative, remember that there are absolutely ways for the lenders to add back certain expenses to get that bottom line positive,” says Morgan.
According to Morgan, these add-backs typically include things like:
- Interest expense
- Compensation of officers
However, Morgan hammers in the point that if your accountant doesn’t record interest expense properly on a business tax return, it can seriously affect the free cash flow analysis lenders typically carry out.
“The bottom line: if you paid interest expense, you should make sure all of that expense is properly calculated on your tax return,” she says, especially if it’s a short-term loan. “The interest add-backs on these can be huge, considering they’re relatively expensive loans.”
For more information on how to calculate and write off your eligible short-term business debt, dig into the IRS Tax Guide for Small Business. Good luck!
The post Here’s What Not to Do When Writing Off Short-Term Debt appeared first on Fundera Ledger.
from Fundera Ledger https://www.fundera.com/blog/2016/03/17/writing-off-short-term-debt/