Why Your Loan Payments Aren't on Your P&L

When looking at your P&L, you may be puzzled to find that your debt payments aren’t shown in your expenses. You’re sure that you made the payment, so why wouldn’t it show?

Want the Cliff-notes?

Your loan payments are not on your P&L because they are not deductible. In other words, the repayment of the loan is just that, a repayment. There’s no tax deduction for a repayment, so we make sure this is categorized on the balance sheet. The interest portion, however, is deductible because the interest is the price you paid (or the cost) of the debt.

If you want to learn more about the details, keep reading!

It all starts when the money is received…

When your company receives a loan from the bank (ex. $10,000) it is not recorded as revenue for the company and therefore would not appear on the company’s P&L for that period. So, in turn, when you make a payment on that debt a portion of the payment is applied to the principal (the initial $10,000 loan) and will not be reported on the P&L.

Okay, but what is the ‘principal’ - I thought it was all one payment?

The original amount of the loan received ($10,000) is the principal amount. That principal is shown on your balance sheet at day one for the full amount of the loan that is outstanding. When a debt payment is made, you are accounting for both the principal amount and the interest incurred for that time period.

In other words, part of the payment goes towards paying down the initial $10,000 principal and the other portion is applied to interest (which will show on your P&L).

I think I get it - but what about taxes? Shouldn’t I get a deduction for the entire debt payment?

A common misbelief is that the entire debt payment should be treated as a deduction to your business income. However, this is an incorrect assumption. Instead, as stated above, the interest portion of the payment is the only piece that shows on the income statement and, thus, is the only portion allowable as a tax deduction.

Well, that doesn’t seem fair? I made the payment, so shouldn’t it be deductible?

Although the cash for the debt payment came out of your bank account, a portion of it was allocated to paying down the principal amount (the initial $10,000). And, because that principal amount of $10,000 was not taxed as revenue when received by your company, it can’t be applied as a tax deduction.

To sum things up

When your company receives the loan for $10,000, you don’t want to be taxed for $10,000 in revenue. So, you record the deposit as a Loan Payable on your balance sheet. That way it isn’t show on your P&L and isn’t taxed by the IRS.

For each payment that is made, the portion of the payment that applies to paying down the original $10,000 can’t be treated as a tax deduction, because you weren’t taxed for that initial in-flux of cash.

At the same time, the portion of the payment that applies to the interest on the loan is an expense which will show on your P&L and as a tax deduction for your business.

Real World Example

If your business borrowed $10,000 from a bank, your company’s cash will increase by $10,000, at the same time your Loans Payable account would also increase by $10,000 - both of which are shown on your balance sheet.

In this example, we’ll assume the business is making regular payments of $1,000 per month, with a 6% simple interest rate. So, $60 of that $1,000 payment goes towards interest and the other $940 goes towards the principal.

What that means is that, only $60 of that $1,000 payment will show on your income statement and be tax deductible. The other $940 will only be seen on the balance sheet as a reduction to cash and the Loan Payable account.

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