Effective for tax years beginning after December 31, 2017, the deduction of interest paid or accrued on a debt incurred in a trade or business other is generally limited regardless how the taxpayer’s business is organized (i.e., corporation, partnership, sole proprietorship, etc.). Code Sec. 163(j). The deduction is limited to the sum of:
business interest income of the taxpayer for the tax year (see §9,915.10b);
30 percent of the taxpayer’s adjusted taxable income for the year (see §9,915.10c), including any increases in adjusted taxable income as a result of a distributive share in a partnership or S corporation, but not below zero; and
floor plan financing interest of the taxpayer for the tax year (see §9,915.10d).
The limitation does not apply to certain trade or businesses, including certain electing real estate and farming businesses (see §9,915.10a). The limitation also does not apply to any small business if its average annual gross receipts for the three tax years ending with the prior tax year do not exceed $25 million, adjusted for inflation after 2018. Code Sec. 163(j)(3). The small business exception is not available to any tax shelter prohibited from using the cash method of accounting (see §45,210.05).
The practical effect of the rule is to limit the deduction of net interest expenses to 30 percent of the taxpayer’s adjusted taxable income. The deduction for business interest and floor plan financing interest is permitted to full extent of business interest income and floor plan financing interest income. If the taxpayer has any interest expenses that exceed these amounts, then the deduction is limited to 30 percent of adjusted taxable income.
The limitation is intended to apply after the application of other limitations on interest. For example, it applies after application of the capitalization rules and to interest that is required to be deferred if paid on an original issue discount (OID) high-yield obligation. The limitation also applies at the level of a consolidated group, but the IRS anticipates an affiliated group that does not file a consolidated return will not be treated as a single taxpayer. Notice 2018-28, 2018-16 IRB 492.
In the case of a partnership or S corporation, the deduction limitation applies at the entity level. See §9,915.20 for a discussion of the application of the limitation to partnerships and S corporations. Any business interest not deductible generally may be carried forward indefinitely to succeeding tax years. See §9,915.30 for a discussion of the general carryforward rule. However, a special carryforward rule applies to partners and partnerships. See §9,915.25 for a discussion of the excess business interest of partnerships.
The disallowance and carryforward of a deduction for a C corporation business interest expense does not affect whether or when such expenses reduce the earnings and profits of the corporation. Notice 2018-28, 2018-16 IRB 492. A C corporation with disqualified interest under the earnings stripping rules for the last tax year beginning before 2018 may carry it forward as business interest to the first tax year beginning after 2017, but subject to the post-2017 interest deduction limitation and the base erosion tax under Code Sec. 59A in the same manner as interest paid or accrued after 2017.
§9,915.10a.Trade or business defined
A trade or business for purposes of calculating the business interest deduction limitation does not include the performance of services as an employee. Code Sec. 163(j)(7)(A). Thus, wages of an employee are not included as part of the taxpayer’s adjusted taxable income.
A taxpayer may elect to exclude from the limitation any real property trade or business as defined under the passive activity rules. An electing real property trade or business is any real estate development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business. Code Sec. 163(j)(7)(B). Thus, interest expenses paid or accrued in the electing real property trade or business is not business interest subject to the limitation. The election is made at a time and manner as provided by the IRS. Once made, the election is irrevocable. If a taxpayer elects to exclude a real property trade or business from the business interest limitation, then the business must use the alternative depreciation system (ADS) for certain property. Code Sec. 163(j)(10)(A). This includes any nonresidential real property, residential rental property, and qualified improvement property held by the electing real property trade or business.
A taxpayer may also elect to exclude from the limitation any farming business as defined under the uniform capitalization rules, as well as any trade or business of a specified agricultural or horticultural cooperative that makes the election. An electing farming business is any trade or business involving the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity. It also includes a trade or business of operating a nursery or sod farm, or the raising or harvesting of trees bearing fruit, nuts, or other crops, or ornamental trees (an evergreen tree that is more than six years old at the time it is severed from the roots is not an ornamental tree). Code Sec. 163(j)(7)(C). Interest expenses paid or accrued in a an electing farming business is not business interest subject to the limitation. The election is made at a time and manner as provided by the IRS. Once made, the election is irrevocable. If a taxpayer elects to exclude a farming business from the business interest limitation, then the business must use the alternative depreciation system (ADS) for any property with a recovery period of 10 years or more. Code Sec. 163(j)(10)(B).
A trade or business for purposes of the limitation does not include the furnishing or sale of a public utility if the rates for the utility are established or approved by a State, political subdivision of a State, agency or instrumentality of the United States, public service or public utility commission, or governing or ratemaking body of an elective cooperative. Code Sec. 163(j)(7)(A)(iv). A regulated public utility includes the trade or business of furnishing or sale of: (1) electrical energy, water, or sewage disposal services, (2) gas or steam through a local distribution system, or (3) transportation of gas or steam by pipeline. Any property primarily used the trade or business of a regulated utility and electric cooperative as described above is not qualified property eligible for the additional first-year depreciation deduction (bonus depreciation). Code Sec. 168(k)(9).
§9,915.10b.Business interest expense and income
Business interest for purposes of the limitation means any interest paid or accrued on debt properly allocable to a trade or business of the taxpayer. It does not include any investment interest. Code Sec. 163(j)(5). Business interest income is the amount of interest includible in the taxpayer’s gross income for the tax year that is properly allocable to a trade or business. It does not include any investment income. Code Sec. 163(j)(6). Solely for this purpose, all interest paid or accrued by a C corporation on debt of the corporation is business interest, and all interest on debt held by a C corporation includible in gross income is business interest income. Notice 2018-28, 2018-16 IRB 492. The IRS intends to issue regulations to address to what extent (if any) interest paid, accrued, or includible in gross income of a noncorporate entity (i.e. partnership) that a C corporation holds an interest is business interest or business interest income of the C corporation.
Investment interest and investment income in this context has the same meaning as for the limitation on the deduction of interest by noncorporate taxpayers under Code Sec. 163(d). Investment interest is interest allocable to property that produces interest, dividends, annuities, royalties, gains, or losses not derived in the ordinary course of a trade or business. It also includes interest in a trade or business activity that is not a passive activity and in which the taxpayer does not materially participate. Investment income is the gross income derived from property held for investment purposes or from its disposition. See §7,414 for a discussion of the limitation on the deduction of investment interest by non-corporate taxpayers.
§9,915.10c.Adjusted taxable income
The adjusted taxable income of a taxpayer for purposes of the limit on business interest is the taxpayer’s regular taxable income computed without regard to:
any item of income, gain, deduction, or loss that is not properly allocable to a trade or business;
any business interest or business interest income;
the amount of any net operating loss (NOL) deduction;
the 20-percent deduction for qualified business income (QBI) of a pass-through entity under Code Sec. 199A (see §10,401); and
in tax years beginning before January 1, 2022, any allowable deduction for depreciation, amortization, or depletion.
The IRS is authorized to provide other adjustments to the computation of adjusted taxable income as it deems necessary. Code Sec. 163(j)(8).
Adjusted taxable income for tax years beginning before January 1, 2022, is computed without regard any deductions for depreciation, amortization, or depletion similar to EBITDA of the business (i.e., earnings before interest, taxes, depreciation, and amortization). Adjusted taxable income for tax years beginning after December 31, 2021, is computed with deductions for depreciation, amortization, or depletion similar to EBIT of the business (i.e., earnings before interest and taxes).
§9,915.10d.Floor plan financing indebtedness
Floor plan financing interest is interest paid or accrued on debt use to finance the acquisition of motor vehicles held for sale or lease to retail customers and secured by the inventory. Code Sec. 163(j)(9), as added by the Tax Cuts and Jobs Act, P.L. 115-97, Act §13301(a). A motor vehicle for this purpose includes any self-propelled vehicle designed for transporting people or property on a public street, highway, or road, as well as a boat, and farm machinery or equipment. Any property used in a trade or business that has had floor plan financing indebtedness is not qualified property eligible for the additional first-year depreciation deduction (bonus depreciation) if the floor plan financing interest to the debt is taken into account for purposes of the business interest deduction limitation. Code Sec. 168(k)(9).