One important change in the tax law mandated by the Tax Cuts and Jobs Act P.L. 115-97, was a new limitation on the deductibility of business interest. Historically, bona fide interest paid on business loans was a deductible expense against any revenue generated by the borrower business. The new limitation presents a striking change from this history as many businesses will find the cost of their financing increased as a result of both the decrease in the federal income tax benefit due to the marginal rate decreases and the limitation, itself.
After ten months of struggling with interpretation of the new limitation, the Internal Revenue Service is now expected to release proposed Treasury regulations on the business interest limitation. It is likely that the reach of the new limitation will be exceedingly broad and affect almost all taxpayers above the safe harbor revenue threshold.
The first set of proposed Treasury regulations for the business interest limitation is expected to focus primarily on corporations. A second package of proposed regulations, expected sometime in December, will reportedly address the business interest limitation’s treatment of partnerships and S corporations.
The intent of the new limitation provision was to add a broader limitation on the business interest expense deduction than that contained in the prior law. Prior to the passage of the TCJA, the former “earnings stripping” rules were applied more narrowly to a specific type of debt-to-equity ratio held by corporations. Now, the amended limitation encompasses all debt, regardless of entity or individual.
The new business interest limitation was intended by tax writers, at least in part, to serve as a revenue raiser to help offset tax reform’s significant corporate tax marginal rate reduction from 35 to 21 percent.
Currently, the proposed Treasury regulations for the business interest limitation are under review at the Office of Management and Budget’s (OMB) Office of Information and Regulatory Affairs (OIRA). OIRA received the proposed regulations from Treasury and the Internal Revenue Service on October 25, according to OIRA’s website.
It is expected on Capitol Hill that a 10-day expedited review process that is available for tax reform-related regulations was requested. Thus, the proposed regulations could be sent back to the Internal Revenue Service and released publicly as early as the end of this week.
Understanding the Business Interest Limitation
Under the amended rule, a taxpayer’s annual business interest expense, effective for taxable years after December 31, 2017, is limited to the following three factors:
- – business interest income for the taxable year;
- – 30 percent of adjustable taxable income (ATI) for the taxable year; and
- – floor plan financing interest for the taxable year.
Note: Under the TCJA, business interest excludes “investment interest” as defined in the Internal Revenue Code. Additionally, it should be noted that under the provision, as written, the calculation requirements for “adjusted taxable income” are set to change in 2022.
It is impossible at this time to surmise exactly what guidance might be set forth in the proposed Treasury regulations. However, Grossman Yanak & Fiord LLP will continue to monitor developments and provide regular postings as the rules advance.