Prior to the Tax Cuts and Jobs Act (TCJA), business interest expense was generally
deductible in the year in which the interest was paid or accrued, except that corporations were subject to certain limitations under IRC Section 163(j) (“the earnings stripping rules”). Under the old law, the deduction for net interest was limited to 50% of adjusted taxable income for firms with a debt-equity ratio above 1.5. Interest above the limit could be carried forward indefinitely.
TCJA repealed the earnings stripping rules and in its place created a more restrictive overall business interest expense limitation predicated on earnings before interest and taxes, rather than a balance sheet ratio. The new tax law limits deductions for business interest incurred by certain businesses. Generally speaking, business interest expense is limited to business interest income plus 30% of the business’s adjusted taxable income and interest on floor plan financing (e.g., financing for the acquisition of motor vehicles, boats or farm machinery held by the taxpayer for sale or lease).
There are some exceptions to the limit, and some businesses can elect out of this limit. For example, disallowed interest above the limit may be carried forward indefinitely, with special rules for partnerships. TCJA provides an exemption from the limitation on interest deductibility for taxpayers (other than tax shelters) whose average annual gross receipts did not exceed $25 million for the three preceding taxable years; however, taxpayers may need to include the gross receipts of related parties for purposes of determining whether this threshold has been met. TCJA also allows farming and real estate businesses to make a one-time irrevocable election to not be subject to the limitation. However, an electing taxpayer is required to use the Alternative Depreciation System (“ADS”) for certain depreciable property, which entails using straight-line depreciation over a longer depreciable recovery period than what is normally allowable for regular tax purposes. An exception from the limitation has also been provided for interest expense on floor plan financing.
The new interest limitation rules will impact primarily leveraged domestic businesses. Nonexempt businesses with high debt levels may find themselves in a difficult position. Please contact Restivo Monacelli as soon as possible to discuss your particular situation. We will determine if you can take advantage of any of the allowed exceptions, as well as provide other strategic planning moves to help minimize your tax liabilities under the new tax laws.