The recently passed tax act has changed the rules for businesses having the ability to deduct business interest expense beginning with tax years after December 31, 2017. The new rule requires special calculations and exempts some taxpayers from the complex set of rules.
In general, the new rule only allows the current expensing of business interest to the extent that it does not exceed the sum of the following:
- The business interest of the taxpayer
- 30 percent of the adjusted taxable income for such year, and
- The floor plan financing interest for such year
Adjusted taxable income means the taxable income of the taxpayer computed without regard to any of the following:
- Business interest or business interest income
- Any net operating loss deduction
- Any deduction allowed under section 199A, and
- Any deduction allowable for depreciation, amortization, or depletion (only applicable for years beginning before January 1, 2022)
For a business operated as a Partnership or S Corporation the above limitations will be calculated at the entity level prior to allocating the taxable income to the owners on the IRS Form K-1.
Any business interest that is disallowed due to these rules will be treated as business interest paid or accrued in the succeeding taxable year. The amounts carried over will continue to be subject to the general rule until it can be deducted. The carryover amounts do not expire.
The new law provides some exemptions to the requirement to follow these rules. The following businesses are exempt:
- A business that has average gross receipts for the prior three years of less than 25 million
- An electing Real Property Trade or Business (includes property development, construction, rental, management and others)
- An electing farming business
- Certain regulated public utilities or certain electric cooperatives
To illustrate these confusing rules let’s look at an example:
Taxpayer has net income of $1,000,000. In determining that income the taxpayer deducted $800,000 of business interest, $210,000 of depreciation and received $10,000 of business interest income.
In this scenario the Adjusted Taxable Income would be the $1,000,000 of net income plus the $800,000 of interest plus the $210,000 of depreciation less the $10,000 of interest income, for a total of $2,000,000. Therefore, the taxpayer would be allowed to deduct $610,000 of interest expense for the current year (30% of $2,000,000 plus $10,000). The current year taxable income would be $1,190,000 and $190,000 of disallowed interest expense would be treated as a deduction in the next taxable year subject to the same calculation to determine deductibility.
Look to Lurie for future information on the Tax Cut & Jobs Act of 2018 (TCJA). To view our updates on TCJA you can check out our website at: www.luriellp.com/news or follow us on social media @LurieLLP.
If you have any questions or would like additional information on how this change could affect you or your business please contact your Lurie advisor.
David D. Brauer
Partner, Tax Services