Business Interest Deduction Limitation: A Little-Known Tax Rule That Could Dramatically Impact Your Taxable Income
By John Juntunen, CPA
When the Tax Cuts and Jobs Act (TCJA) was signed into law in late 2017, it brought wholesale change to the Internal Revenue Code. Some of the new tax rules, such as the “parking lot deduction limitation” and the “199A deduction” have received their fair share of press. Other rules, however, have largely flown under the radar.
One rule that taxpayers are starting to feel the effect of is the “section 163(j) limitation,” also known as the business interest deduction limitation. Prior to the TCJA, this rule applied only to certain interest paid or accrued by corporations. However, things now have changed.
Here’s what you should know about section 163(j), and how it could impact your taxable income this year.
Unless it meets certain gross-receipt exemptions, your business could be subject to 163(j).
In light of the changes brought by the TCJA, any entity that has $26 million or more in annual gross receipts is subject to the business interest deduction limitation rules. These rules reduce the amount of business interest an entity can deduct on its tax return. Determining the exact amount of interest an entity can deduct requires a series of “limitation calculations.” Business interest expense should not exceed the sum of business interest income, floor plan financing interest, and 30% of adjusted taxable income (ATI).
This is also important to note: Taxpayers who own 80% or more of multiple entities may be required to aggregate these entities when performing the $26 million annual gross receipts test.
If you’re subject to 163(j): Can you (and should you) elect out?
Certain entities are eligible to elect out of section 163(j). These primarily include real property entities, such as real estate-related business and certain farming entities. But here’s the catch: If an entity elects out, it must depreciate certain assets using an alternative depreciation system instead of the general system. This can represent a significant undertaking, and the net tax result may not be all that advantageous.
If your entity is subject to section 163(j), and you would like to explore your options for electing out, it’s important to let your tax advisor know as soon as possible.
How can you limit the effect of section 163(j)?
When it comes to these rules, it’s wise to stay ahead of the game. And this requires proper tax and business planning. For example, you might be able to limit the effect of section 163(j) by strategically timing out your plans to refinance existing debt, obtain new debt, or purchase equipment and other assets.
What should you do now?
First, you and your tax advisor should determine whether or not your business or entity is subject to section 163(j). If you think it might be, ask your tax advisor if you can and should elect out. (You can elect out when you file your income tax return.)
Also, keep in mind that this article represents the tip of the section 163(j) iceberg. There are other, more nuanced aspects of the rule that could impact your business. If you have questions or concerns about section 163(j) and how it could affect your taxable income, reach out to an AEM tax advisor today.
On December 20, 2019, President Trump signed into law the Consolidated Appropriations Act and the Further Consolidated Appropriations Act. Within this legislation was the Setting
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