United States: Are Your Business Interest Expenses Deductible?

Before Congress passed the Tax Cuts and Jobs Act (TCJA), most business-related interest expenses were deductible, although corporations could not deduct interest paid to or guaranteed by a related party under certain circumstances. But for tax years beginning after 2017, the TCJA imposes a limit on business interest deductions, with exceptions for small businesses and electing real estate and farming businesses.

All businesses should evaluate the impact of the new deduction limit on their tax liability and plan accordingly.

Do you qualify for the small business exemption?

The business interest deduction limit does not apply to small businesses, defined as those whose average annual gross receipts for the preceding three years is $25 million or less. Certain related businesses must aggregate their gross receipts for purposes of the $25 million threshold. This requirement is designed to prevent larger businesses from splitting themselves into several smaller entities to avoid the limit.

How do you calculate the limit?

If the limit applies to your business, your annual deduction for business interest expense cannot exceed the sum of 1) your business interest income, if any, 2) your floor plan financing interest, if any, and 3) 30% of your adjusted taxable income. In other words, you can use an unlimited amount of business interest expense to offset business interest income, and you can fully deduct floor plan financing interest, which is commonly used by vehicle dealers and large appliance retailers to finance their inventories.

Any interest in excess of those amounts is limited to 30% of adjusted taxable income. Be aware that business interest income and expense does not include investment interest income or expense. Disallowed interest expense may be carried forward indefinitely.

Adjusted taxable income means taxable income, computed without regard to:

  • Nonbusiness income, gain, deduction or loss;
  • Business interest income or expense;
  • Net operating loss deductions;
  • The 20% deduction for qualified business income of pass-through entities and sole proprietorships; and
  • For tax years beginning before 2022, depreciation, amortization or depletion.

For tax years beginning after 2021, depreciation, amortization and depletion will be subtracted in computing adjusted taxable income, shrinking business interest deductions even further.

Special rules apply to pass-through entities. For partnerships, the business interest limit applies at the entity level, but any interest in excess of the limit is passed through to the partners and carried forward on their individual tax returns. The partnership also passes through "excess taxable income"—the amount by which the deduction limit exceeds actual interest expense. Partners can offset this amount against unused interest deductions. For S corporations, the limit also applies at the entity level, but unused deductions are carried over at the entity level until they can be offset against corporate income.

Should you opt out?

Certain real property and farming businesses may elect not to apply the limit on business interest expense deductions. Real property businesses include development, construction, reconstruction, acquisition, conversion, rental, operation, management, lending and brokerage businesses.

If you are eligible to opt out of the deduction limit, doing so can yield significant tax benefits. But these benefits come at a price. After you make the election, which is irrevocable, you must depreciate certain business property under the alternative depreciation system (ADS). This means longer recovery periods and lower depreciation deductions. For real property businesses, ADS applies to nonresidential real property, residential rental property and qualified improvement property. For farming businesses, it applies to any property held by the business with a recovery period of ten years or more.

To determine whether making the election is right for your business, you need to weigh the benefits of unlimited business interest deductions against the cost of lower depreciation deductions.

Have a plan

If your business is subject to the business interest limitation, be sure to evaluate the impact of reduced interest deductions on your tax liability. If it is significant, you might consider strategies for reducing your interest expense, such as relying more heavily on equity financing instead of debt.

If your business owns debt-financed real property, another option is to transfer such property to a separate entity, such as a partnership that you control, in a sale-leaseback transaction and have the entity opt out of the interest limitation as a real property business. For this strategy to work, there must be a legitimate business purpose for the transaction other than tax avoidance.

Sidebar: IRS guidance is on the way

The IRS plans to issue regulations on the application of the business interest limit. In the meantime, the IRS has issued Notice 2018-28, which provides interim guidance on several issues, including:

  • Pre-Tax Cuts and Jobs Act Interest
    The guidance suggests that disallowed interest carried forward under prior law will be treated as business interest expense in the first tax year after 2017 and subject to the new limit.
  • Corporations
    According to the guidance, the regulations will provide that, for purposes of the business interest limit, all C corporation interest expense and income, even if investment-related, will be treated as business interest expense and income.
  • Pass-Through Entities
    The guidance provides rules to avoid double counting of income and expense by pass-through entities and their owners.
  • Consolidated Groups
    The net interest expense limitation is determined on a consolidated basis, without considering obligations between group members. The regulations will provide technical rules.
  • Earnings and Profits
    The guidance clarifies that disallowed interest expense will nevertheless reduce a corporation's earnings and profits.

Tax Connections Newsletter – Winter 2019

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Lowndes, Drosdick, Doster, Kantor & Reed, P.A.
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Lowndes, Drosdick, Doster, Kantor & Reed, P.A.
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions