Publication 535 |
2001 Tax Year |
Interest You Cannot Deduct
Certain interest payments cannot be deducted. In addition, certain
other expenses that may seem to be interest are not, and you cannot
deduct them as interest.
You cannot currently deduct interest that must be capitalized, and
you generally cannot deduct personal interest.
Interest paid with funds borrowed from original lender.
If you use the cash method of accounting, you cannot deduct
interest you pay with funds borrowed from the original lender through
a second loan, an advance, or any other arrangement similar to a loan.
You can deduct the interest expense once you start making payments on
the new loan.
When you make a payment on the new loan, you first apply the
payment to interest and then to the principal. All amounts you apply
to the interest on the first loan are deductible, along with any
interest you pay on the second loan, subject to any limits that apply.
Capitalized interest.
You cannot deduct interest you are required to capitalize under the
uniform capitalization rules. See Capitalization of Interest,
later. In addition, if you buy property and pay interest owed by
the seller (for example, by assuming the debt and any interest accrued
on the property), you cannot deduct the interest. Add this interest to
the basis of the property.
Commitment fees or standby charges.
Fees you incur to have business funds available on a standby basis,
but not for the actual use of the funds, are not deductible as
interest payments. You may be able to deduct them as business
expenses.
If the funds are for inventory or certain property used in your
business, the fees are indirect costs and you must capitalize them
under the uniform capitalization rules. See Capitalization of
Interest, later.
Interest on income tax.
Interest charged on income tax assessed on your individual income
tax return is not a business deduction even though the tax due is
related to income from your trade or business. Treat this interest as
a business deduction only in figuring a net operating loss deduction.
Penalties.
Penalties on underpaid deficiencies and underpaid estimated tax are
not interest. You cannot deduct them. Generally, you cannot deduct any
fines or penalties.
Interest on loans with respect to life insurance policies.
You generally cannot deduct interest on a debt incurred with
respect to any life insurance, annuity, or endowment contract that
covers any individual unless that individual is a key
person.
If the policy or contract covers a key person, you can deduct the
interest on up to $50,000 of debt for that person. However, the
deduction for any month cannot be more than the interest figured using
Moody's Corporate Bond Yield Average-Monthly Average Corporates
(Moody's rate) for that month.
Who is a key person?
A key person is an officer or 20% owner. However, the number of
individuals you can treat as key persons is limited to the greater of
the following.
- Five individuals.
- The lesser of 5% of the total officers and employees of the
company or 20 individuals.
Exceptions for pre-June 1997, contracts.
You can generally deduct the interest if the contract was issued
before June 9, 1997, and the covered individual is someone other than
an employee, officer, or someone financially interested in your
business. If the contract was purchased before June 21, 1986, you can
generally deduct the interest no matter who is covered by the
contract.
Interest allocated to unborrowed policy cash value.
Corporations and partnerships generally cannot deduct any interest
expense allocable to unborrowed cash values of life insurance,
annuity, or endowment contracts. This rule applies to contracts issued
after June 8, 1997, that cover someone other than an officer,
director, employee, or 20% owner. For more information, see section
264(f) of the Internal Revenue Code.
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