The IRS has announced initial guidance for computing the business interest expense deduction under Code Sec. 163(j) effective for tax years beginning after 2017, and aspects that will be covered in future regulations. The deduction is generally limited to the taxpayer’s business interest income plus 30 percent of the taxpayer’s adjusted taxable income. The new limitation was added by the Tax Cuts and Jobs Act ( P.L. 115-97) and applies to all taxpayers.
Under the regulations, C corporations with disqualified interest under the earnings stripping rules of Code Sec. 163(j) prior to 2018 may carryover the interest to post-2017 tax years, but subject to the limitations under the new rules. The carried over interest will also be subject to the base erosion tax under Code Sec. 59A in the same manner as interest paid or accrued after 2017. Additional guidance will be provided for allocation of business interest from an affiliated group and consolidated returns. Any disallowed and carried forward interest deduction will not affect whether or when such interest expense reduces earnings and profits.
The new Code Sec. 163(j) limitation is generally applied at the entity level with respect to partnership or S corporation debt, but also may be applied at the partner or shareholder level. However, the future regulations will provide that “double counting” will not be allowed. A partner’s or shareholder’s annual deduction for business interest may not include the partner’s or shareholder’s share of the entity’s business interest income for the tax year, except to the extent of the partner’s or shareholder’s share of the excess of the entity’s business interest income over the entity’s business interest expense. A partner or shareholder also cannot include their share of the entity’s floor plan financing interest in determining the deduction.