This guide is for S corporation owners, bookkeepers, and Australian businesses or preparers handling US federal filings. It covers US Form 1120-S rules only, not Australian interest deductions. We'll cover what Line 13 includes, how to separate interest from principal and other costs, how Section 163(j) can cap the deduction, and how the amount flows through the return.
Key Takeaways
- Line 13 holds only trade or business interest not claimed elsewhere on the return.
- Classify interest by how the borrowed money was used.
- Section 163(j) can defer part of the deduction and may require Form 8990.
- Tie Line 13 to loan records, total deductions, Schedule K, and each K-1.
What Is Form 1120-S Line 13 Interest Expense?
What Line 13 captures
On the 2025 form, Line 13 reads "Interest (see instructions)." The instructions say to include only interest incurred in the corporation's trade or business activities that isn't claimed elsewhere on the return, per the Form 1120-S instructions.
Interest is the cost of borrowing. Principal repayments only reduce the debt, so they are never part of this deduction. Financing charges need a closer look:
- Points: prepaid interest, generally not fully deductible when paid
- Debt issuance fees: generally spread over the debt's term
- Original issue discount: generally deducted using a constant-yield method
- Commitment fees: treated differently from interest; review the facts before posting them
How Line 13 fits into page 1
The allowable amount joins the other deductions on Lines 7 through 20, which total on Line 21. Line 22 (Line 6 less Line 21) is ordinary business income or loss. That figure carries to Schedule K, line 1, and to K-1 box 1.
Don't repeat the amount on Line 20. That line is for other allowable business deductions, listed by type and amount in an attached statement.
How interest reaches shareholders
Operating interest lowers ordinary income, so shareholders see it through box 1, not as a separate interest deduction. Other categories take their own paths, covered below.
Interest limited under Section 163(j) stays with the S corporation as a carryforward. It does not pass to shareholders when disallowed.
Why the debt's purpose matters
Tax treatment follows what the borrowed funds paid for, not the loan's name or the account used to pay interest. One loan can need splitting if proceeds funded working capital, an investment, a rental, personal spending, or a distribution.
Which Interest Expenses May Be Reported on Line 13?
Ordinary business borrowing
Interest on debt used in the active business qualifies, subject to limits. That covers working capital, operating costs, equipment, and business property. Keep records of the lender, loan terms, payment dates, balances, and proof of business use.
Credit cards, lines of credit, and refinanced debt
Review each facility and separate interest from principal, late charges, and other fees. Interest follows the use of proceeds under the tracing rules in Reg. 1.163-8T.
- Replacement debt keeps the allocations of the debt it repaid
- Extra proceeds follow their own uses
- Collateral doesn't decide the treatment
For mixed-use debt, trace the proceeds and record the allocation when it happens, not months later.
Related-party and shareholder loans
Loans from shareholders, officers, or related companies need more care. Keep a written agreement, interest rate, repayment terms, payment history, and evidence the debt is genuine.
Timing matters too. An accrual-method S corporation generally deducts interest owed to a related party, including any shareholder, in the year the recipient includes it in income. The lender's interest income should match.
Shareholder debt basis is a separate question from deductibility. A direct, bona fide loan can create basis, but that doesn't make the interest deductible on its own.
Interest subject to Section 163(j)
The general ceiling is business interest income plus 30% of adjusted taxable income plus floor plan financing interest. Small businesses are exempt if they pass the gross receipts test and aren't a tax shelter. The threshold, based on the preceding three years' average, is:
| Tax year beginning in | Gross receipts amount |
|---|---|
| 2024 | $30 million |
| 2025 | $31 million |
| 2026 | $32 million |
Under IRS Form 8990 instructions, tax years beginning after 2024 restore the depreciation, amortisation, and depletion add-backs to ATI. For years beginning after 2025, the limit generally covers capitalised interest too, with exceptions.
Form 8990 is generally required when the corporation has business interest expense or a disallowed carryforward, unless an exclusion applies. Form 8990 lines 41 and 42 feed separately stated K-1 items (box 17, codes AA and AB), which differ from disallowed interest that stays at the corporate level.
Interest that must be treated elsewhere
Line 13 is not a catch-all. Interest goes elsewhere when it relates to:
- Rental real estate: Form 8825, then Schedule K line 2 and K-1 box 2
- Other rental activities: Schedule K line 3b
- Investment activity: Schedule K line 12c and K-1 box 12, code H
- Distribution debt: Schedule K line 12e and K-1 box 12, code AC
- Production or construction property: capitalised under Section 263A
- Tax-exempt obligations: disallowed under IRC 265(a)(2)
Note that investment interest is box 12, code H. Box 13 is for credits.
How to Calculate and Report Line 13 Interest Expense
Start with the accounting records
Gather these source documents:
- General ledger, year-end P&L, and trial balance
- Bank and card statements
- Loan statements, amortisation schedules, and notes
- Lender confirmations
Reconcile interest accounts to actual payments or accruals under the corporation's accounting method. Flag principal, fees, personal charges, and misposted items.
Classify each borrowing by use
Build a debt-by-debt schedule with these columns:
- Lender
- Opening balance
- New borrowing
- Principal repaid
- Interest charged
- Ending balance
- Purpose of proceeds
For mixed-use loans, document the split between business, rental, investment, personal, and shareholder uses before anything goes to Line 13.
Calculate the deductible amount
- Start with the interest supported by loan records.
- Remove principal, personal or unsupported amounts, and costs to be capitalised or reported elsewhere.
- Apply Section 163(j) and document the result.
- Check timing.
Cash-method taxpayers deduct interest when paid, but prepaid interest allocable to later periods is treated as paid in those periods. Accrual-method taxpayers deduct interest as it economically accrues. Related-party rules can defer the deduction.
Enter and reconcile
Enter only the allowable current-year business interest on Line 13. Attach Form 8990 where required, and follow the instructions for any statements. Report interest tied to other activities on the proper form.
Then tie Line 13 to the interest workpaper and confirm the effect on Line 21, Line 22, Schedule K, and each K-1. Track disallowed, capitalised, or separately stated amounts separately.
A classification example (no numbers)
A corporation takes one term loan. Most proceeds buy delivery vehicles. A smaller part funds a shareholder's personal expense. Monthly payments include principal and interest.
- Strip out principal first
- Allocate interest between the vehicle use and the personal use
- Only the business share is a Line 13 candidate, then tested under 163(j) if applicable
- The personal share stays off Line 13 and is reviewed for shareholder treatment
What Should Not Be Reported on Line 13?
Principal, personal, and unsupported amounts
Principal repayments, distributions, draws, personal expenses, and undocumented charges aren't deductible interest. A bank-feed description or ledger label isn't proof. You need loan documents and a business purpose.
Items reported elsewhere
Rental, investment, tax-exempt, inventory, construction, and designated-property interest may need separate reporting or capitalisation. Check the current instructions before assuming Line 13.
Duplicate or misclassified expenses
Interest already in cost of goods sold, depreciation, another schedule, or the Form 8990 calculation shouldn't appear again. And Line 20 is not a fallback for interest that was limited, omitted, or hard to classify.
Records, Review, and When to Get Help
Documentation checklist
Keep:
- Loan agreements and lender statements
- Amortisation schedules and cancelled payments
- Bank and card records
- Debt-purpose and allocation workpapers
- Related-party agreements
- Form 8990 support
Each record should show borrower, lender, amount, interest, payment date, business purpose, any related-party link, and the return treatment. The IRS generally says to keep records for 3 years, 6 years if omitted income exceeds 25% of gross income shown, and indefinitely if no return was filed.
Final review and escalation triggers
Before filing, confirm:
- You used the current form
- The Line 13 total agrees with the books
- Principal is excluded from the interest total
- Mixed-use debt is allocated
- Nothing is duplicated on the return
Get professional review for:
- Related-party or cross-border loans
- Foreign-currency debt
- Significant refinancings
- Distributions funded by debt
- Rental or investment activities
- Ownership changes
- Large disallowed-interest balances
- Any uncertainty about Form 8990
Foreign lenders raise extra withholding questions. US-source interest paid to foreign persons generally faces 30% withholding unless relief applies. The US-Australia treaty generally caps source-country tax on interest at 10%. Forms 1042-S and W-8BEN may be involved.
Getting support with Form 1120-S
VJM Global provides bookkeeping, US tax compliance, payroll, and financial management for Australian and international businesses, including year-end financial reports used to prepare corporate tax returns. Its team includes CPAs and chartered accountants trained in US standards, and it serves 250+ Australian businesses. That support helps reconcile interest accounts to loan records before a return is prepared.
Australian owners should also get separate advice on S corporation eligibility (nonresident aliens can't be direct shareholders), US filing obligations, Australian reporting, foreign exchange, withholding, and treaty issues.
This article is general information, not tailored tax advice. Rules change by tax year, so check current IRS instructions or consult a qualified adviser.
Frequently Asked Questions
What is Form 1120-S Line 13?
It's the line for deductible trade or business interest not reported elsewhere on the S corporation return, subject to current IRS rules and limits.
Is interest expense deductible for an S corporation?
Qualifying business interest can be. The debt's use, documentation, capitalisation rules, separate-activity rules, and Section 163(j) all affect the current deduction.
What interest expense goes on Line 13 of Form 1120-S?
Allowable interest from the active business. Principal, personal interest, rental or investment interest, and amounts reported elsewhere don't automatically belong there.
Does Section 163(j) limit an S corporation's interest deduction?
Yes, unless a small-business exemption applies ($31 million average gross receipts for 2025 years). Disallowed interest carries forward at the corporation, and Form 8990 is generally required.
Does interest expense flow to Schedule K-1?
Deductible operating interest reduces ordinary income, which reaches shareholders in box 1. Rental, investment, and distribution interest, and Form 8990 items, follow separate K-1 paths.
Can shareholder loan interest be reported on Line 13?
Interest on a genuine business loan from a shareholder may qualify. You need the agreement, terms, payment records, and proper related-party timing, and the shareholder must report the interest income.
