The impact of the Tax Cuts and Jobs Act (TCJA) can vary significantly by industry. Trucking is likely to see one of the largest effects within the machinery industry. One of the more notable changes stemming from the TCJA relates to new limitations on business interest deductions.
Before the TCJA 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
- Thirty percent of the adjusted taxable income of the taxpayer (but not less than zero), plus
- Eligible floor plan financing interest for the taxpayer
For trucking entities with higher leverage, 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
- Twenty 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 nondealership trucking companies.
Real property trades or businesses can elect out of the new business interest expense limitations. Read more about how a 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.
When applying these new laws specifically to the trucking industry, some potential tax planning opportunities arise. The capital-intensive nature of this industry positions it well to take advantage of tax reform. With significantly lower tax rates, U.S. transportation companies of all sizes will have the opportunity to use increased positive cash flow to upgrade their fleets to more fuel-efficient vehicles. Under the new temporary 100 percent bonus depreciation rules, which are effective until January 1, 2023, purchased vehicles would qualify for full expensing the year of purchase, excluding purchases from related parties.
It’s important to note how the timing of the temporary 100 percent bonus depreciation aligns with the business interest deduction limitation. As previously mentioned, for tax years before January 1, 2022, deductions for depreciation are added back to taxable income for purposes of calculating adjusted taxable income. After this date, however, the 30 percent limitation will be based on taxable income post-depreciation. This could have a significant effect on the amount of allowed interest deduction in a capital-intensive industry like trucking.
With this in mind, there is the opportunity to accelerate capital expenditures before January 1, 2022, to avoid significant effects on allowable interest deductions in the future. If you think this new business interest deduction limitation could affect your business, contact Nick or your trusted BKD tax advisor to discuss potential tax planning strategies.