Building Your Business Business Taxes How Amortization Affects Your Business Taxes By Jean Murray Jean Murray Facebook Twitter Jean Murray, MBA, Ph.D., is an experienced business writer and teacher who has been writing for The Balance on U.S. business law and taxes since 2008. She has taught accounting, business law, and business finance at business and professional schools for over 35 years, has authored several books on saving money and simplifying your business, and was the owner of startup-focused company Emence Enterprises, LLC. learn about our editorial policies Updated on September 19, 2022 Fact checked by J.R. Duren Fact checked by J.R. Duren J.R. is a terms editor at The Balance, a role in which he focuses on providing clear answers to common questions about personal finance and small business. J.R. has more than 10 years of experience reporting, writing, and editing. As an editor for The Balance, he has fact-checked, edited, and assigned hundreds of articles. learn about our editorial policies Share Tweet Pin Email In This Article View All In This Article Amortization vs. Depreciation How Amortization Works for Loans How Amortization Works for Intangible Assets Calculating for Tax Purposes Frequently Asked Questions (FAQs) Photo: BartekSzewczyk / Getty Images Amortization can be 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, it's the process of paying down the loan by making payments, which include both principal and interest. Amortization of expenses spreads out the expense of an asset over its useful life for tax purposes. Key Takeaways Amortization deals with intangible assets, whereas depreciation deals with tangible assets.With loans, amortization refers to your schedule for paying off the loan with payments that include interest and principal.For business purposes, you use amortization to expense the cost of intangible property over the course of the property's useful life.Businesses can use amortization of expenses to lower their tax liability. Amortization vs. Depreciation Depreciation and amortization use essentially the same process but for different types of assets. While depreciation expenses the cost of a tangible asset such as a piece of equipment over its useful life, amortization deals with expensing intangible assets like trademarks or patents. Amortization is similar to straight-line depreciation—the cost of the asset is spread out in equal increments over the years of its useful life. How Amortization Works for Loans An amortization schedule is often used to show the amount of interest and principal that's paid on a loan with each payment. It's basically a payoff schedule showing the amounts paid each month, including the amount that's attributable to interest 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 before you commit to it. You'll need to know the amount of the loan, the interest rate, the amount of any deposit you intend to put down, and the term or length of the loan. You can then get an estimate of what the monthly payment will be. For example, if you take out a $400,000 loan for 15 years with 20 percent down at a 5.25 percent interest rate, the monthly payment will be approximately $1,881. For mortgages, interest will make up a big chunk of your initial payments, but, over time, more of your payment will go toward the principal. How Amortization Works for Intangible Assets You'll need the value of the asset and its estimated useful life to calculate amortization for an asset. Its useful life is the time period over which it's expected to be of use to your business. The amount amortized is the same for each year so the calculation is relatively simple. For example, a company might have a patent that it spent many years and $1 million in costs to develop. The patent's useful life is estimated at 15 years, so the company can claim $66,667 in amortization expenses each year—$1 million divided by 15. Note In general, an asset is intangible if it has no physical substance, is non-financial (e.g. not a security), and has a lifespan of more than one tax reporting cycle. Calculating Amortization for Tax Purposes Amortization is a legitimate expense of doing business and this expense can be used to reduce your company's taxable income. The current year's amortization expenses, like depreciation expenses for the year, should appear on your company's income statement or profit and loss statement. An amortization calculation is included when a company prepares its income tax return for all allowable assets that are being amortized. You'll use IRS Form 4562 for the calculation. The form includes both depreciation and calculation of depreciation for a listed property as well as amortization. Depreciated assets are listed first, then assets that are amortized are listed next. The calculations are then transferred to the main tax return form, which can vary depending on the type of business. How Business Startup Costs Are Amortized Business startup costs are treated somewhat differently. The IRS requires that you amortize startup costs, but it does allow up to $5,000 of startup costs to be deducted during the first year of business. Frequently Asked Questions (FAQs) What is an example of an amortization expense? Your company owns a patent that has a useful life of 10 years. The patent cost you $1 million to develop and obtain. So, you amortize the expense at a rate of $100,000 per year for 10 years. Why do we amortize expenses? Amortization helps business reduce their tax liability as they acquire and create intangible assets that can help them grow and succeed. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. California Department of General Services. "Depreciation and Amortization—8616." Cornell Law School Legal Information Institute. "Amortization." The University of Arizona. "Financial Policies: 2.20 Capitalization of Intangible Assets." IRS. "Instructions for Form 4562 (2021)." IRS. "Publication 535 (2021), Business Expenses," Click on "Business Start-up and Organization Costs" in left sidebar.