Last year, we discussed Internal Revenue Code §163(j) created by the Tax Cuts and Jobs Act of 2017 ("TCJA"). At the time, we knew business interest expenses were limited to 30% of Adjusted Taxable Income + business interest income + floor plan financing interest expense. We also knew businesses with gross receipts of $25 million or less were "excepted" from the limitation and that certain businesses were "excepted" out of the law (utility companies) or could elect to be excepted out (farms and real estate). Despite being complicated, it seemed at the time that the law would not affect too many people…if only that was the case now.
In December 2018, the IRS released proposed regulations for §163(j) that threw several wrenches into most CPAs’ previous analysis of the tax law. If you need to get up to speed on this area of the tax law, please read parts one and two in this blog series.
And now - “This is where the fun begins.”
The first issue was the compliance side of the code section now applied to every single pass-through business and taxpayer that is a partner, member, or shareholder of those businesses, even though the limitation would only affect businesses/individuals with gross receipts of $25 million or more. The IRS explained that pass-throughs must disclose certain information (such as average gross receipts) to their members/shareholders—whether or not they are subject to the limitation. This complicates many tax returns and creates extra compliance work for tax professionals and, in turn, higher tax compliance costs for businesses. If you are a member of a large number of pass-throughs, give your tax advisor a hug next time you see them.
Another issue arose with tax shelters. Under the expanded definition in the regulations, many businesses that generate a loss for the tax year and pass a portion of that loss on to passive members, fall within the definition of a tax shelter. Tax shelters must apply the business interest limitation—whether or not they are a small business. Real estate owners may feel a tremendous impact from this. Operating at a loss is the norm for many real estate development projects. A real estate business deemed a tax shelter could still elect to opt out of the limitation, since it is one of the "excepted" trades or businesses. Yet, because the election is irrevocable and comes with stipulations attached, it is hardly a no-brainer and requires a complicated forecast for even your most sophisticated tax professional, let alone your seasoned meteorologist.
While I wish we could tell you it ended there, several other complex issues lurk inside the several hundred pages of proposed regulations for §163(j). For example, although both partnerships and S Corporations are pass-throughs, the regulation treats them differently. Furthermore, the proper interest expense limitation for partnerships requires an 11-step calculation (and a PhD in quantum physics). The term “interest expense" itself includes a laundry list of items in the regulations that the IRS links to costs relating to the use money.
Where do we go from here?
Luckily, there is a path forward. If the word "tax" is not part of your job description, we recommend you consult a tax advisor if you think you may be affected by § 163(j), and possibly even if you don’t, just to be sure. The most important take away is that tax laws are becoming increasingly complicated as a result of the TCJA’s attempt at “simplification” and filing tax returns will involve several new considerations and decisions having long-term effects on your tax filings and possibly your ultimate liabilities.
In these trying (or for this topic we should say limiting) times, The Tax Warriors® at Drucker & Scaccetti are here to assist you with all your tax needs. If you have any questions or concerns regarding the impact of §163(j) or any other tax-related topic, contact us, we are always prepared to help.