Business Interest Limitation and the Tax Cuts and Jobs Act - Part I

Posted on Wed, May 30, 2018 ©2021 Drucker & Scaccetti

Ferman1By: Jeremy Ferman, CPA

 

Despite what you may have heard, The Tax Cuts and Jobs Act (“TCJA”) adds more intricacy to the already complex U.S. Tax Code.  One of the new provisions in the TCJA is the Business Interest Expense Limitation, IRC section 163(j).  Today, in the first of two parts, we’ll try to crack the code (pardon the pun) and shed some light on one of the more complex changes of the new tax law.

 

Background

 

The Business Interest Expense Limitation allows for the deduction of business interest expense to be no greater than 30% of the business’s Adjusted Taxable Income (“ATI”), plus business interest income, plus floor-plan financing interest (interest expenses on large items of inventory such as cars, boats, or planes).  If your business interest expense is greater than the number calculated in the limitation calculation, then the excess interest expense is disallowed as a deduction, carried forward, and treated as interest expense in the following year.  

 

ATI is defined as your business’s taxable income less business interest income, business interest expense, depreciation/amortization (until 2022), net operating loss (“NOL”), any pass-through deduction from 199A, and any non-business income/expense.  This is important to remember, since companies showing losses from items such as a NOL or depreciation (at least until January 1, 2022) may still deduct some or all business interest expense.

 

Here’s Where It Gets Tricky

 

This limitation can be problematic for heavily leveraged companies, and it adds an additional consideration when deciding how best to finance your business.  The good news is the limitation does not apply to everyone.  Foremost, the limitation does not apply to any businesses with average gross receipts of less than $25 million in the preceding three years.  The gross receipts test is calculated every year, meaning a business with a particularly good year may subject itself to the interest limitation for the next three years.  Likewise, a poor year by a business could exempt it out of the limitation. 

 

The TCJA requires this test be calculated by aggregating the gross receipts from all related businesses.  Any corporation considered part of a consolidated group that must file a consolidated tax return is considered related and must be grouped together to determine subjection to the business interest limitation.  On the pass-through entity side, businesses under common control are treated as a single entity for the purposes of the limitation.  This will be an important planning point as you cannot avoid the business interest limitation by sub-dividing your business.  

 

The second exception codified in section 163(j) is the “certain trade or business exception.” This exception is simply a list of business activities that either exempt you from needing to apply the interest limitation or allow you to elect out of being subject to the limitation.  Utilities are exempt from the limitation, and farms and real estate businesses may elect to ignore it.  And lending companies and car dealerships are effectively exempt from the limitation due to including business interest income and floor-plan financing interest expense as separate items in the business interest limitation calculation.

 

The new section 163(j) Business Interest Expense Limitation is very complex.  It is one of the many parts of the new tax law requiring in-depth knowledge of the tax code to apply. 

 

The Tax Warriors® at Drucker & Scaccetti have decades of experience with the most complex and confusing parts of the tax code.  Call on us to help you understand this or any other provision of the new tax law so you can properly plan for business growth.  Next week, in Part II of this two-part series, we will discuss how the Business Interest Expense Limitation affects real estate companies and pass-through entities.

Topics: NOL, TCJA, ATI, business interest expense, IRC section 163(j), Business Interest Expense Limitation

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