The Tax Cuts and Jobs Act (TCJA), enacted in late 2017, brought numerous changes to the U.S. tax code, including a significant update to the business interest deduction rules under Internal Revenue Code Section 163(j). From the enactment of Section 163(j) in 2017 (effective for the 2018 tax year) through today, many modifications have been made to the interest limitation rules.
What Is The 163(j) Limitation?
Section 163(j) limits the amount of business interest expense a taxpayer can deduct in a taxable year. Specifically, for most taxpayers, the deduction is capped at 30% of the adjusted taxable income (ATI) for that year, plus any interest income. This limitation primarily affects larger businesses and those with significant financing costs. When originally enacted through the TCJA, ATI was defined (broadly) as tax-based EBITDA, or taxable income, excluding net interest expense, depreciation, net interest expense, depreciation and amortization. Beginning in 2022, the computation of ATI was modified to tax-based EBIT, thus eliminating an adjustment for depreciation and amortization expense. Given the favorable depreciation provisions in the TCJA (i.e., accelerated depreciation options via bonus depreciation), the interest expense limitation had a much broader impact on taxpayers.
Impact Of The One Big Beautiful Bill
The One Big Beautiful Bill reverted the definition of ATI to once again be tax-based EBITDA. Coupled with the revived 100% bonus depreciation, this was a welcome change as the interest expense limitations under Section 163(j) may be greatly reduced.
Example: Applying The 163(j) Limitation
Suppose a manufacturing company, XYZ Manufacturing, has a taxable income of $5 million, tax expense of $500,000, tax depreciation expense of $2,000,000, and $25,000 of amortization expense. The company incurs $2,500,000 in business interest expenses for the year.
Under Prior Law (30% of EBIT)
In this example, ATI would be $7,600,000 ($5,000,000 of taxable income plus $2,500,000 of interest expense plus $100,000 of taxes). Thirty percent of ATI would be $2,280,000. The portion of disallowed interest would be $220,000.
Under New Law (30% of EBITDA)
In this example, ATI would be $9,625,000 ($5,000,000 of taxable income plus $2,500,000 of interest expense plus $100,000 of taxes plus $2,000,000 of depreciation plus $25,000 of amortization). Thirty percent of ATI would be $2,887,500. Since this amount is greater than the $2,500,000 of interest expense, there is no limitation under Section 163(j), thus preserving a tax deduction of $220,000 compared to prior law.
Key Points:
- The cap is generally 30% of ATI.
- Carry-forward provisions allow disallowed interest to be carried forward to future years.
- Certain exempt entities, like small businesses under specific thresholds, may be excluded from the limitation.
How GBQ Partners Can Help
The 163(j) interest expense limitation is a highly complex area that requires advanced tax planning and review when taking on significant amounts of leverage. GBQ can explore methods to reduce exposure to the interest expense limitation through advising on debt structuring, aggregation of related companies for purposes of computing the interest expense limitation, or electing to alternative tax options to avoid the interest expense limitation.
Conclusion
The 163(j) limitation, as introduced by the One Big Beautiful Bill, underscores the importance of comprehensive tax planning for businesses. Understanding how to navigate and strategize around these rules can lead to substantial savings and better financial health. Engaging knowledgeable advisors, such as the professionals at GBQ Partners, can provide the guidance needed to adapt to this evolving tax landscape effectively. Contact us today.
By Kyle Porter, CPA, Manager, Tax & Advisory, and Ryan Kilpatrick, CPA, CCIFP, Partner, Tax & Advisory
Seeking additional OBBBA guidance? Check out these resources:
One Big Beautiful Bill Act’s Impact On Federal Information Reporting
IRS Issues Transitional Guidance On Reporting Interest From Specified Passenger Vehicle Loans
Opportunity Zones Evolve: Comparing TCJA & OBBBA Legislation For Investors & Communities
