![]() 14 Commodities or other similar securities trading or hedging businesses are not excluded. 13 Businesses with annual average gross receipts over the prior 3 years of $25 million or less are also excluded. 12 Once made, the elections for real estate and farming businesses are irrevocable, and such businesses will be required to use a longer depreciation method. There are key exclusions from the new interest expense limitation rule for specified trades or businesses: the performance of services as an employee, electing real estate businesses (specifically, a real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business), electing farm businesses, and certain regulated public utilities. 11 As will be seen below, the computation of adjusted taxable income is further complicated for taxpayers with interests in partnerships or S corporations that have incurred entity-level debt. 10 Treasury is given discretion to make other adjustments to this calculation. More specifically, adjusted taxable income means taxable income computed without regard to (1) any item of income, loss, gain, or deduction that is not allocable to a trade or business, (2) any business interest income or expense, (3) the amount of any net operating loss deduction under section 172, (4) the amount of any deduction allowed under section 199A (enacted under the TCJA to provide a new 20% deduction for business income of pass-through entities), and (5) for taxable years beginning before January 1, 2022, any depreciation, amortization, and depletion deductions. “Adjusted taxable income” is generally computed using a formula that mimics EBITDA through 2021, but then starting in 2022 a harsher definition kicks in that mimics EBIT. 8 The legislative history indicates that, for corporations, the investment interest exclusion is intended to apply only to non-corporate entities and thus that all interest income and expense will be treated as allocable to a business of the corporation and will be subject to limitation, unless one or more of its businesses can qualify for another exclusion. “Business interest” includes interest allocable to a trade or business and excludes “investment interest” (as defined in section 163(d), which contains a separate limitation applicable to investment interest expense of non-corporate taxpayers). 7 In the same vein, the inclusion of business interest income as a threshold for the limitation allows business interest expense to be deductible up to the amount of such income ( i.e., only taxpayers with net business expense are subject to limitation on the net amount). As a fixed part of the threshold for the limitation, floor plan financing interest is effectively deductible without limitation under section 163(j)-an exception sought by the vehicle dealer industry. “Floor plan financing” interest is attributable to debt incurred to finance the acquisition of motor vehicles held for sale or lease and secured by the inventory so acquired. 5 Disallowed interest expense may be carried forward indefinitely to succeeding taxable years. 4 This limitation applies after other potential limitations on deductibility of interest expense are considered, including interest capitalization rules or other disallowance provisions. In general, the business interest expense deduction is disallowed to the extent incurred in a taxable year in excess of (a) business interest income, (b) 30% of the taxpayer’s adjusted taxable income (defined below), and (c) floor plan financing interest. 3 It disallows deductions for business interest expense that exceeds an adjusted earnings-based threshold. New section 163(j) applies for interest expense incurred in taxable years after December 31, 2017. New section 163(j) applies more broadly to all debt, whether between related parties or incurred by a corporation, other entity, or individual, and regardless of the taxpayer’s debt-to-equity ratio. Former section 163(j) generally limited interest deductions for certain related-party debt and certain guarantees by affiliates of third-party debt: it applied to corporations with a debt-to-equity ratio greater than 1.5 to 1 in a taxable year. 2 New section 163(j), which replaces the old “earnings stripping” rules, generally limits deductions for net interest expense of a business. In signing into law the legislation commonly referred to as the “Tax Cuts and Jobs Act” or the “TCJA,” 1 President Trump made good on threats in recent proposals to curb the tax advantages of business leverage.
0 Comments
Leave a Reply. |