How Amortization Affects Your Business Taxes

Amortization for Loans and Business Assets

What is amortization? 

Amortization is a confusing tax term. it's similar to depreciation, and it works like depreciation, but it's used for different kinds of business assets. Amortization actually has several meanings: 

  • In relation to loans, amortization is the process of paying down the loan by making payments which include both principal and interest.
  • Amortization is also related to the concept of depreciation; that is, spreading out the expense of an asset over a period of time, for tax purposes. 

    Depreciation and amortization use essentially the same process, but for different types of assets. While depreciation expenses the cost of a tangible asset over its useful life, amortization deals with expensing an intangible asset, like a trademark or patent. 

    Amortization is similar to straight-line depreciation, which means that the cost of the asset is spread out in equal amounts over the years of its life. 

    How amortization works for loans

    An amortization schedule is often used to show the amount of interest and principal for a loan with each payment. Here is an example of an amortization table for a loan, from Justin Pritchard, Banking/Loans Expert. This schedule is basically a payoff schedule, showing the amounts paid on the loan each month, including the amount of interest paid, and a running total for the interest paid over the life of the loan. 

    You can use an online loan amortization calculator to find the monthly payment on a loan.

    You will need to know the amount of the loan, the interest rate, the amount of deposit, and the term of the loan. You can then get an estimate of the monthly payment. 

    For example, if XYZ company has a $400,000 loan, for 15 years, with 20% down, at 5.25% interest, the monthly payment will be approximately $1881.00

    How amortization is calculated for intangible assets 

    To calculate amortization for an asset, you will need the value of the asset and its estimated useful life (the time period over which it is of use to the business). 

    In this case, since the amount amortized is the same for each year, the calculation is simple. For example: A company has a patent that it spent many years, and $1,000,000 in costs, to develop. The patent's useful life is estimated at 15 years, so the company can take $66,667 in amortization expense each year. 

    How amortization is calculated for tax purposes 

    It's important to remember that amortization is a legitimate expense of doing business, and that this expense may be used to reduce the company's taxable income. 

    The current year's amortization expenses, like depreciation expense for the year, are shown on the company's income statement (profit & loss statement)

    When a company does its income tax return, an amortization calculation is included for all allowable assets that are being amortized. The form used for the calculation of amortization is IRS Form 4562: Depreciation and Amortization. The form includes both depreciation and calculation of depreciation for listed property as well as for amortization calculations.

     

    New assets to be amortized are listed first, then assets that are continuing to be amortized are listed. The calculations are transferred to the business main tax return form, depending on the type of business. 

    How business startup costs are amortized 

    Business startup costs are a particular case of amortization. The IRS requires that startup costs be amortized, but it does allow $5,000 of startup costs to be deducted during the first year of business.