The Tax Cuts & Jobs Act (TCJA) contains a limitation on the deduction of business interest. The Internal Revenue Code [IRC] Section [§] 163(j) – limitation of business interest has be modified and the deduction for business interest is limited to the sum of:

1. Business interest income;
2. 30 percent of the adjusted taxable income of the taxpayer for the taxable year; and
3. The floor plan financing interest of the taxpayer for the taxable year.

The amount of any business interest not allowed as a deduction for any taxable year may be carried forward indefinitely beyond the year in which the business interest was paid or accrued, treating business interest as allowed as a deduction on a first-in, first-out basis. The limitation applies at the taxpayer level. In the case of a group of affiliated corporations that file a consolidated return, the limitation applies at the consolidated tax return filing level. This new limitation on the deductibility of business interest creates a temporary difference between the interest being deducted for book purposes and that which will be allowed for tax purposes. This deductible timing difference will most likely create a deferred tax asset for which a determination of its utilization in future tax years needs to be evaluated and determined.

EXCEPTIONS:

Apart from the exclusions to be discussed or those business that may elect out, the new interest deduction limitation applies to all businesses, regardless of form. Any disallowance or excess limitation would generally be determined at the filer level (e.g., at the partnership level instead of the partner level).

The new limitation does not apply to the trade or business of performing services as an employee. Certain taxpayers may elect for the interest expense limitation not to apply, such as certain real estate businesses and certain farming businesses. Businesses that make this election must use the alternative depreciation system (ADS) to depreciate certain property. For an electing real estate business, ADS would be used to depreciate nonresidential real property, residential real property, and qualified improvement property. For an electing farming business, ADS would be used to depreciate any property with a recovery period of 10 years or more.

$25 MILLION GROSS RECEIPTS EXCEPTION:

The limitation does not apply to any taxpayer that meets the $25 million gross receipts test of § 448(c) – – that is, if the average annual gross receipts for the three-taxable-year period ending with the prior taxable year does not exceed $25 million. Aggregation rules apply to determine the amount of a taxpayer’s gross receipts under the gross receipts test of § 448(c).

DEFINITIONS:

1. Business Interest – Business interest means any interest paid or accrued on indebtedness properly allocable to a trade or business. Any amount treated as interest for purposes of the IRC is interest for purposes of this provision. Business interest income means the amount of interest included in the gross income of the taxpayer for the taxable year which is properly allocable to a trade or business. Business interest does not include investment interest, and business interest income doe not include investment interest income within the meaning of § 163(d).

2. Adjusted Taxable Income – adjusted taxable income means the taxable income of the taxpayer computed without regard to:

a) Any item of income, gain, deduction, or loss which is not properly allocable to a trade or business;
b) Any business interest or business interest income; and
c) The amount of any net operating loss deduction; and
d) Deduction under §199A with respect to qualified business income of a pass-through entity.

FLOOR PLAN FINANCING INTEREST:

Floor plan financing interest means interest paid or accrued on floor plan financing indebtedness. Floor plan financing interest means indebtedness to finance the acquisition of motor vehicles held for sale or lease to retail customers and secured by the inventory so acquired. A motor vehicle mean any self-propelled vehicle designed for transporting persons or property on a public street, highway or road. By including business interest and floor plan financing interest in the limitation, the rule operates to allow floor plan financing interest to be fully deductible and to limit the deduction for the net interest expense (less floor plan financing interest) to 30 percent of adjusted taxable income. That is, a deduction for business interest is permitted to the full extent of business interest income and any floor plan financing interest. To the extent that business interest exceeds business interest income and floor plan financing interest, the deduction for the net interest expense is limited to 30 percent of adjusted taxable income.

CARRYFORWARD OF DISALLOWED BUSINESS INTEREST:

The amount of any business interest not allowed as a deduction for any taxable year is treated as business interest paid or accrued in the succeeding taxable years. Interest deductions may be carried forward indefinitely, subject to certain restrictions applicable to partnerships.

Whichever rule imposes the lower limitation on deduction of business interest with respect to the taxable year (an therefore the creates mount of interest to be carried forward) governs. Any carryforward of disallowed business interest is an item taken into account in the case of certain corporate acquisitions described in IRC § 381 and is subject to limitation under § 382.

Please contact us if you have any questions regarding the new limitation on business interest expense.