Since the passing of the Tax Cuts and Jobs Act (TCJA) in late 2017, taxpayers have had more questions than answers on many topics. Baby steps were made with IRS Notice 2018-28, which provides some temporary guidance on the business interest expense deduction under Code Sec. 163(j) until the IRS issues final regulations.
The Old Law
Under previous law, a corporation could not deduct “disqualified” interest if (1) the company’s debt exceeded 1.5 times its equity and (2) its net interest expense was greater than 50% of its adjusted taxable income (taxable income without regard to deductions for net interest expense, net operating losses, domestic production activities, depreciation, amortization, and depletion).
Disqualified interest or interest subject to the limit under previous law included interest paid or accrued to (1) related parties when the interest was not subject to federal income tax, (2) unrelated parties in cases where a related party guaranteed the debt, or (3) real estate investment trust (REIT) by a taxable REIT subsidiary of that REIT.
Interest disallowed for a taxable period (due to the 50% of adjusted taxable income limit) could be carried forward indefinitely and any excess limitation (the excess of 50% of the borrower’s adjusted gross income over its net interest expense) for a taxable period could be carried forward three years.
Also under the previous law, members of the same affiliated group were treated as one taxpayer for purposes of the interest deduction limitation.
The New Law
The TCJA amended Section 163(j) of the Internal Revenue Code. For tax years beginning after 2017, a corporate OR noncorporate taxpayer with more than $25 million of average annual gross receipts, has an annual business interest expense limited to the sum of:
- The taxpayer’s business interest income,
- 30% of the taxpayer’s adjusted taxable income, and
- The taxpayer’s floor plan financing interest paid by vehicle dealers for the tax year.
While the new law still permits disallowed interest to be carried forward indefinitely, it does not permit excess limitation to be carried forward.
Real estate and farming businesses can elect to exempt themselves from the Section 163(j) interest limitation; however, there are a couple of items to keep in mind:
- Once election is made, it is irrevocable.
- Businesses must use the alternative depreciation system (ADS) for certain property (generally, real or farm property with a recovery period of 10 years or more) used in business regardless of when the property was placed in service. ADS depreciation is over longer tax lives and is not eligible for bonus depreciation.
Additional Topics to be Addressed
According to this temporary guidance, the IRS will issue regulations clarifying the following items:
- Treatment of pre-2018 interest carryforwards
- C corporations business interest income and expense
- Treatment of consolidated groups
- The regulations are not expected to treat an affiliated group that doesn’t file a consolidated tax return as a single taxpayer for purposes of the business interest expense deduction.
- Business interest income and floor plan financing of partnerships, partners, S corporations, and S corporation shareholders
The IRS has requested comments on the rules outlined in Notice 2018-28. In addition, the IRS expects to issue regulations providing additional guidance with respect to issues not addressed in this notice and request comments on what additional issues should be addressed. Comments must be submitted by May 31, 2018.