July 9, 2018

The Tax Cuts and Jobs Act (TCJA) has significantly lowered tax rates for businesses and changed many deductions.  One of the biggest and most important changes is the deductibility of business interest expense, which is creating complexity and confusion.  This provision is expected to raise $250 billion in taxes over the next ten years.

In the past, business interest expense has been generally deductible, but with some limitations.

For tax years beginning after December 31, 2017 and before January 1, 2022, deductible business interest expense is limited to:

  • 30% of adjusted taxable income before depreciation, amortization and depletion
  • plus business interest income and floor plan financing interest

Starting in 2022, deductible business interest expense will be limited to:

  • 30% of taxable income only
  • plus business interest income and floor plan financing interest

Business interest expense does not include investment interest expense or floor plan financing interest (secured motor vehicle inventory).  Any business interest expense that is not deductible is carried forward indefinitely.  Special rules for the carryover interest will apply to partnerships.

Adjusted taxable income is taxable income before interest expense, interest income, net operating loss and the 20% qualified business income deduction (Section 199A).  The 30% of adjusted taxable income cannot be less than zero.

Small businesses (those with average gross receipts of $25 million or less for the three prior years) other than tax shelters are not subject to this business interest expense limitation.  The aggregation rules apply to related businesses.

Real property trades/businesses and farm businesses can elect out of this interest limitation if they do not claim bonus depreciation and use the alternative depreciation system (ADS) to depreciate applicable real property and farm property (for assets with a useful life longer than 10 years).  Once the election is made, it’s irrevocable.

For partnerships and S corporations, the business interest limitation is applied at the entity level to ordinary business income or loss.  It does not include any separately stated items of income or loss.  There are special rules to eliminate double counting of income and to utilize excess taxable income.

What actions should businesses take?

The intent is for businesses to become less leveraged and more stable, which should create a more stable economy.  For the next several years, highly leveraged or less profitable companies may start to feel the effects of this new business interest expense limitation.  It can make financing more expensive.  Starting in 2022, this limitation will affect many businesses.

Now is the time to plan for how and when the business interest expense limitation will affect your business.  Businesses should consider doing the following:

  • Determine if the business meets the small business exception (≤$25 million) and for how long?
  • Prepare projections of income, fixed asset acquisitions, debt levels and interest rates for the future.
  • Determine if an election is appropriate for real property trades/businesses and farm businesses.

The results could be higher taxes or a change in the debt and equity structure of the business.  It could affect how you do business today and in the future.

Please contact your Clark Nuber professional or Rene Schaefer to understand this new tax provision and how it affects your business.

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This article contains general information only and should not be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. Before making any decision or taking any action, you should engage a qualified professional advisor.