IRS Provides Additional Guidance for Business Interest Expense Limitation Elections Under the CARES Act

Thoughtware Alert Jun 01, 2020
Government

Before the Tax Cuts and Jobs Act (TCJA) went into effect for tax years beginning after December 31, 2017, business interest expense generally was 100 percent deductible. The TCJA amended Internal Revenue Code (IRC) Section 163(j), subjecting taxpayers to limitations on the amount of business interest expense they can deduct. The TCJA offers a few exceptions to the general §163(j) limitation rules, including those for electing real property trades or businesses and electing farm businesses. These elections are provided under §163(j)(7). 

Unless a taxpayer qualifies for an exception, the deduction for business interest expense is limited to the sum of:

  • Business interest income
  • Thirty percent of adjusted taxable income (ATI)
  • Floor plan financing interest

The Coronavirus Relief, Aid, and Economic Security Act (CARES Act) made additional amendments to §163(j), including several elections taxpayers can make related to their 2018, 2019 and 2020 tax years.

On April 10, 2020, the IRS and U.S. Department of the Treasury (Treasury) released Revenue Procedure 2020-22 describing the time and manner in which certain taxpayers can make the various elections provided by the CARES Act related to §163(j), including:

  1. Extension of time for certain businesses to make or withdraw a §163(j)(7) election
  2. Election out of the 50 percent ATI limitation for taxable years beginning in 2019 and 2020
  3. Election for a taxpayer to use its ATI for the last taxable year beginning in 2019 to calculate its §163(j) limitation for taxable year 2020
  4. For partners, election out of deducting 50 percent of excess business interest expense (EBIE), without limitation, for taxable years beginning in 2020

Extension of Time to Make or Withdraw a §163(j)(7) Election

As previously mentioned, two notable exceptions to the §163(j) business interest expense provisions are provided for electing real property trades or businesses and farming businesses. While these businesses may elect out of the interest expense limitations, there is a trade-off. The election, under the TCJA, is irrevocable and requires real property trades or businesses to use the alternative depreciation system (ADS) for any of its nonresidential real property, residential real property and qualified improvement property. Similarly, electing farming businesses would be required to use the ADS method to depreciate farming property with a recovery period of 10 years or more.  

Revenue Procedure 2020-22 provides immediate transition guidance for taxpayers affected by the various retroactive amendments the CARES Act made to the TCJA, including the technical correction which allows taxpayers to apply the accelerated bonus depreciation rules to qualified improvement property, i.e., the retail glitch fix. The technical fix to the “retail glitch” is likely to change the analysis many real property trades or businesses underwent while deciding whether to elect out of the §163(j) limitation.

Making a Late §163(j)(7) Election

A taxpayer may make the election to be an electing real property trade or business or electing farming business for tax years 2018, 2019 or 2020 by filing an amended federal income tax return or administrative adjustment request (AAR) on or before the earlier of October 15, 2021, or the date upon which the applicable period of limitations on assessment for the tax year expires. See the section below titled “Amended Partnership Returns Allowed for 2018 & 2019” for new relief granted to partnerships wishing to make changes to previously filed returns. The taxpayer must include the following information on the amended return or AAR:

  1. An adjustment to taxable income for the late election and any collateral adjustments to taxable income or tax liability 
    1. Collateral adjustments include those made to the amount of depreciation allowed for the year. For an explanation of how to change to the ADS method for existing property, see Section 4.02 of Revenue Procedure 2019-8
    2. Collateral adjustments must be made on an amended income tax return or AAR, as applicable, for any affected succeeding tax year
  2. An election statement titled “Revenue Procedure 2020-22 Late Section 163(j)(7) Election,” which includes the following:
    1. The taxpayer’s name, address and tax identification number
    2. A description of the taxpayer’s electing trade or business, including the principal business activity code
    3. A statement that the taxpayer is making an election under §163(j)(7)(B) or 163(j)(7)(C), as applicable

Withdrawing a §163(j)(7) Election 

A taxpayer may withdraw a §163(j)(7) election for tax years 2018, 2019 or 2020 by timely filing an amended federal income tax return or AAR for the tax year in which the election was made and including an election withdrawal statement. The amended return or AAR must be filed on or before the earlier of October 15, 2021, or the date upon which the applicable period of limitations on assessment for the tax year expires. The taxpayer must include the following information on the amended return or AAR:

  1. An adjustment to taxable income for the withdrawn election and any collateral adjustments to taxable income or tax liability
    1. Collateral adjustments include those made to the amount of depreciation allowed for the year. Depreciation for any property that’s affected by the withdrawn election must be determined in accordance with §168
    2. Collateral adjustments must be made on an amended income tax return or AAR, as applicable, for any affected succeeding tax year
  2. An election withdrawal statement titled “Revenue Procedure 2020-22 Section 163(j)(7) Election Withdrawal,” which includes the following:
    1. The taxpayer’s name, address and tax identification number
    2. A statement that the taxpayer is withdrawing its election under §163(j)(7)(B) or §163(j)(7)(C), as applicable, pursuant to Revenue Procedure 2020-22

Election Out of the 50 Percent ATI Limitation

The CARES Act further amended §163(j) by providing special rules for applying the business interest expense limitation to taxable years beginning in 2019 and 2020. The CARES Act retroactively increases the amount of business interest expense that may be deductible for these taxable years by computing the §163(j) limitation using 50 percent, rather than 30 percent, of a taxpayer’s ATI. Taxpayers can elect not to apply the 50 percent ATI limitation to any taxable year beginning in 2019 or 2020 and instead use the 30 percent ATI limitation. However, partnerships must continue to use the 30 percent ATI limitation for 2019. 

The process for electing out of the 50 percent ATI limitation is straightforward: A taxpayer wishing to make the election should simply use the 30 percent limitation on its applicable tax form. No formal statement is required to make the election. Taxpayers wishing to revoke such an election may do so by timely filing an amended income tax return or AAR, as applicable, using the 50 percent ATI limitation. 

Election to Use 2019 ATI for a 2020 Taxable Year

The CARES Act also allows a taxpayer to elect to substitute its ATI for the last taxable year beginning in 2019 for the taxpayer’s 2020 ATI in determining its §163(j) limitation. Again, the process for making this election is relatively easy: A taxpayer must simply use its 2019 ATI when calculating the §163(j) limitation on its 2020 tax return. No formal statement is required to make or revoke this election. 

Election Out of the 50 Percent EBIE Rule

Finally, the CARES Act provides special rules for partnership and partners for taxable years beginning in 2019. Instead of a 50 percent limitation for partnerships, a partner will treat 50 percent of its allocable share of a partnership’s 2019 EBIE as an interest deduction in the partner’s first taxable year beginning in 2020, without limitation. A partner may elect out of this treatment. 

Similar to the two elections discussed above, the election out of the 50 percent EBIE rule also is quite straightforward: A partner must simply not apply the 50 percent EBIE rule on the tax return filed for its first taxable year beginning in 2020. Instead, the partner will continue to carry forward the EBIE under the normal §163(j) pass-through rules. 

Amended Partnership Returns Allowed for 2018 & 2019

On April 8, 2020, the IRS and Treasury released Revenue Procedure 2020-23, which allows certain partnerships to amend their 2018 and 2019 returns that were previously unable to be amended pursuant to the centralized partnership audit regime in effect for tax years beginning after December 31, 2017. Prior to this revenue procedure, these partnerships would have to file an AAR to adjust a return. If an AAR was filed in 2020 for a 2018 tax return, the partners would not receive the benefit of the deduction until they filed their 2020 income tax returns in 2021.   

Since the intention of the CARES Act is to provide tax relief to taxpayers as soon as possible, Revenue Procedure 2020-23 will allow partners to amend their 2018 and 2019 returns to claim the additional tax benefits included in the CARES Act. The partnership’s amended return and accompanying Schedules K-1 must be filed before September 30, 2020, and include the statement “Filed pursuant to Revenue Procedure 2020-23” at the top.

While this revenue procedure provides partnerships with an easier option to take advantage of claiming the additional bonus depreciation on qualified improvement property in 2018, taxpayers should consider whether filing an accounting method change with a 2019 return and claiming the additional 2018 bonus depreciation via a negative §481(a) adjustment would be administratively easier or result in a greater tax benefit.

We’ll continue to monitor tax-related legislation and keep you up to date with relevant news, changing guidelines and new regulations in the BKD COVID-19 Resource Center. As with most topics related to COVID-19, changes are being made rapidly. Please note that this information is current as of the date of publication. If you have questions, reach out to your BKD Trusted Advisor™ or submit the Contact Us form below.

Kate & Ben — How can we help you? Contact Us!

How can we help you?