The Tax Cuts and Jobs Act of 2017 (“TCJA” P.L. No. 115-97) significantly changed the interest deductibility rules for business interest expense for tax years beginning after December 31, 2017. As many businesses are coming to the close of their taxation year, it may be prudent to review how these changes will impact current year taxable income.
On November 27, 2018, Treasury and the IRS released proposed regulations (REG-106089-18). These proposed regulations addressed the business interest expense limitation under IRC §163(j) as amended. The proposed regulations provide guidance as to the application of IRC §163(j) to C Corporations, consolidated groups, pass-through entities (partnerships, LLCs and S-corporations), and foreign corporations.
IRC §163(j) sets a limitation on the amount of business interest that may be deducted in computing taxable income. The amount, allowed as a deduction, shall not exceed the sum of:
- The business interest income of such taxpayer for such taxable year,
- 30 percent of the adjusted taxable income of such taxpayer for such taxable year (which shall not be less than zero), plus
- The floor plan financing interest of such taxpayer for such taxable year.
Adjusted taxable income as defined means “the taxable income of the taxpayer
(A) computed without regard to
- Any item of income, gain, deduction, or loss which is not properly allocable to a trade or business,
- Any business interest of business interest income,
- The amount of any net operating loss deduction,
- The amount of any deduction for qualified business income (IRC §199A),
- For taxable years beginning before January 1, 2022, any deduction allowable for depreciation, amortization or depletion, and
(B) computed with such other adjustments as provided by the Secretary.”
Business interest expense would not include any other interest expense that is permanently disallowed as a deduction pursuant to another provision of the Internal Revenue Code. Any business interest expense which is not, currently, deductible, will be carried forward and treated as business interest expense paid or accrued in the succeeding taxable year.
Small businesses, however, are excluded from this limitation. IRC §163(j)(3) specifically provides that paragraph (1) does not apply to such taxpayer for such taxable year if they are under the gross receipts test of IRC §448(c). In general, a corporation or partnership will meet the gross receipts test, for any taxable year, if the average annual gross receipts of such entity for the 3-taxable year period ending with the taxable year, preceding the current year, does not exceed U.S. $25,000,000.
Many small private business (for example Canadian controlled private corporations) will be under this gross receipts test threshold. As such, IRC §163(j) will have little or no impact on them and their shareholders. For larger businesses, however, these new limitations need to be considered in terms of both computing taxable income and the potential after-tax cost of financing additional investments in the company (I.e., fixed asset additions, etc.)
Given all the changes, and their respective implementation dates, taxpayers need to be cognizant of all the changes that the Tax Cuts and Jobs Act encompassed.
We at Cadesky U.S. Tax strive to keep our clients up to date on all relevant U.S. tax issues. If you have any questions or needs please do not hesitate to reach out to your Cadesky U.S. Tax team member.