To Pay Off Business Debt Early or Not?
Terms of the loan
If your loan terms are very favorable, such as having locked in an ultra-low interest rate, or there are flexible payments, you may be better off keeping your loan and investing your windfall elsewhere, such as in a business expansion, additional inventory, building improvements, or necessary repairs. These can increase the value or capacity of your business, and possibly increase your income. Likewise, if your loan terms are terrible, such as a high interest rate, high payments, or you have a balloon payment that you may not be able to refinance, it may make more sense to pay it off early.
Size of profit margin
If you have a healthy profit margin and can easily continue to make the loan payments, your need to repay the loan is much less than if you have very tight profit margins and struggle to make your business profitable. Perhaps paying a portion of the loan back and refinancing might put you in a better situation, provided you can find favorable terms.
Tax consequences
The final factor to consider is the tax consequences of paying off your loan. A taxpayer in the 25% bracket operating a sole proprietorship, pays 25% of his or her business's profit to the federal government in the form of federal income taxes. Outside of rental real estate, there are also self-employment taxes that eat up another 15.3% of business profit. This means that just over 40% of business profits are being sent to the IRS. Pay off your business loan early, and as much as 40% of your freed up payments will be made to Uncle Sam because you have more net profit. As interest on business loans is deducted from a business's profits, you may be better off using that money to grow your investment, and use the interest you are paying to lower your tax burden. As always, with any tax advice, consult a tax professional to see what will work best for your situation.
Published by R. D. Lamont
R. D. Lamont holds a B.S. in Business Information Systems and is a current MBA student, specializing in finance and international business. Currently working as a software engineer in the financial services... View profile
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