October 20, 2023
Business taxpayers may have limitations on their interest expense deductions for tax years beginning after December 31, 2017.
Code Sec. 163(j) limitation. For tax years beginning after December 31, 2017, the business interest expense deduction allowed for a tax year is generally limited to the sum of:
business interest income for the tax year;
30 percent of adjusted taxable income (ATI), but not less than zero; and
the taxpayer’s floor plan financing interest.
Points to Note
Business interest expense is any interest expense properly allocable to a non-excepted trade or business, or that is floor plan financing interest. It does not include any investment interest.
If the section 163(j) limitation applies, generally the amount of any business interest expense that is not allowed as a deduction under section 163(j) for the tax year is carried forward to the following year as a disallowed business interest expense carryforward.
A taxpayer’s adjusted taxable income for the purpose of the 163(j) limit is the taxpayer’s tentative taxable income for the tax year with certain adjustments. Beginning in 2022, ATI is similar to EBIT (earnings before interest and taxes). For tax years beginning before January 1, 2022, ATI is similar to EBITDA of the taxpayer (earnings before interest, taxes, depreciation, and amortization).
There are exceptions to the business interest limitation if taxpayers meet certain requirements. One exception includes certain small businesses whose average gross receipts are $29 million or less for 2023 ($27 million for 2022), electing real property trades or businesses, electing farming businesses, and certain regulated public utilities.
Example
X-Ray Corp. is a domestic corporation. During its tax year ending December 31, it has ATI of $100,000, business interest expense of $50,000, which includes $10,000 of floor plan financing interest expense, and business interest income of $20,000.
X-Ray’s deduction limit for the year is $60,000 which is the sum of its business interest income ($20,000), plus 30 percent of its ATI ($100,000 x 30 percent = $30,000, plus its floor plan financing interest expense ($10,000). Because the corporation’s business interest expense does not exceed the limit, it can deduct all $50,000 of its business interest expense for the tax year.
Reference: https://www.irs.gov/pub/irs-pdf/p535.pdf
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