For the first time ever, the Tax Cuts and Jobs Act (TCJA) imposes a limit on business interest deductions, effective this year. Now, the IRS has announced it issued new proposed regulations on this (IR-2018-233, 11/26/18).
Notably, certain small companies are exempted from the deduction limit. This is based on their earnings during the past three years.
Here’s the lowdown: For tax years beginning after 2017, the deduction for business interest expenses is generally limited to the sum of a taxpayer’s business interest income, 30 percent of their adjusted taxable income (ATI) and floor plan financing interest.
For these purposes, ATI is defined as business income without regard to:
- Income, deduction, gain or loss not properly allocable to a company
- Business interest income and expense
- Net operating losses (NOLs)
- The new 20 percent qualified business income deduction for pass-through entities
- For tax years beginning before 2022, any deduction allowable for depreciation, amortization or depletion
Any excess business interest can be carried forward indefinitely.
However, the new limit doesn’t apply to a qualified small company with average annual gross receipts of $25 million or less for the three prior tax years. This number will be adjusted annually for inflation in 2019 and thereafter.
But that’s not all. The TCJA allows other exclusions from the limit, such as certain trades or businesses, including performing services as an employee, electing real property trades or companies and electing farming businesses and certain regulated public utilities. Taxpayers must elect to exempt a real property trade or business or a farming organization from the limit.
The new proposed regulations are extremely complex. To summarize, they provide guidance with respect to the following subjects:
- Common definitions
- General rules for computing a taxpayer’s limit
- Ordering and other rules explaining the relationship of the limit and other tax code provisions that affect interest
- Rules or C corporations, including real estate investment trusts (REITs), regulated investment companies and consolidated group members, and tax-exempt corporations
- An explanation of how disallowed business interest expense carryforwards of C corporations are treated
- Special rules explaining how partnerships and S corporations apply the limit
- An explanation of how the limit applies to foreign corporations and their shareholders
- Rules on how the limit applies to foreign persons with effectively connected income
- Rules for elections for trades or businesses that are excepted from the rules as well as a safe harbor for certain REITs
- An explanation of how to allocate expenses and income between non-excepted and excepted trades or businesses
- Certain transition rules for applying the business interest deduction limit
Taxpayers must use new Form 8990, Limitation on Business Interest Expense Under Section 163(j), to calculate and report their deduction. This document is also used to figure out the amount of any disallowed business interest expense that may be carried forward to next year.
Both taxpayers and practitioners can rely on the proposed regulations until the final ones are issued.
About Ken Berry
Ken Berry, Esq., is a nationally known writer and editor specializing in tax, financial, and legal matters. During his long career, he has served as managing editor of a publisher of content-based marketing tools and vice president of an online continuing education company. As a freelance writer, Ken has authored thousands of articles for a wide variety of newsletters, magazines, and other periodicals.