Before the Tax Cuts and Jobs Act passed, business interest expense generally was 100 percent deductible. Effective for tax years beginning after December 31, 2017, taxpayers may be subject to limitations on the deductible amount of business interest expense. If a taxpayer experiences a limitation on the deductible amount of business interest expense, the disallowed business interest expense may be carried forward indefinitely.
Some small taxpayers meeting a gross receipts test may be eligible to deduct business interest expense without regard to the new limitations. The gross receipts test is met if the taxpayer’s average gross receipts from the prior three tax years are equal to or less than $25 million.
Regardless of entity type, the limitation is calculated at the entity level. The limitation is based on the sum of:
- Business interest income for the taxpayer for such taxable year, plus
- 30 percent of the adjusted taxable income of the taxpayer (but not less than zero), plus
- Eligible floor plan financing interest for the taxpayer
For construction entities, limitations may likely apply due to business interest expense exceeding 30 percent of the entity’s adjusted taxable income. Adjusted taxable income is an entity’s taxable income computed without regard to:
- Income, gain, deduction or loss not allocated to a trade or business
- Any business interest expense or business interest income
- 20 percent pass-through deduction, Section 199A, enacted with tax reform
- Any net operating loss deduction
- Tax years before January 1, 2022, deductions for depreciation, amortization or depletion
Eligible floor plan financing indebtedness is debt used to finance the acquisitions of motor vehicles held for sale or lease, which are essentially considered inventory. This debt isn’t likely to apply to construction companies.
Real property trade or businesses can elect out of the new business interest expense limitations. This article summarizes how real property trade or business may elect out of this limitation.
If a taxpayer experiences a limitation on the amount of business interest expense deductible for a taxable year, the disallowed business interest shall be treated as business interest paid or accrued in the succeeding taxable year. S corporations and C corporations follow the general carryforward rules by treating disallowed interest as business interest paid or accrued in the following year, while partnerships must follow special rules for carryforwards.
For partnerships, instead of the disallowed business interest being treated as business interest paid or accrued in a following tax year, the entire business interest expense without regard to any limitations reduces each partner’s basis by the partner’s allocation percentage in the partnership. Though the entire deduction will reduce the partner’s basis in his or her interest in the partnership, the deduction passed through to the partner will be limited as discussed above at the partnership level. In essence, a partner will see a reduction in basis without necessarily seeing a corresponding deduction on his or her tax return. The future deductibility of the disallowed interest will be determined at the partner level.
Be sure to visit BKD’s Tax Reform Resource Center for more information on the new law, including a one-page summary of the new interest limitation rules. If you think the new business interest deduction limitation will apply to your business, contact Ryan or your tax professional to discuss planning strategies that can lessen the effect of this new provision.