TOPIC

Business Interest Expense Limitation

Last Updated Dec. 2, 2020

A taxpayer may deduct interest paid or accrued within a tax year on a valid debt. Prior to the Tax Cuts and Jobs Act of 2017 (TCJA), business interest expense was generally deductible in the year the interest was paid or accrued, subject to certain limitations.

The TCJA replaced the earnings stripping rules in §163(j) by limiting the deduction for net business interest expense to 30% of a taxpayer’s “adjusted taxable income,” with an exemption for small businesses.

The current iteration of §163(j) is considerably more encompassing than its predecessor; it applies:

  • Regardless of whether the debt is between related parties
  • Regardless of whether the debt is incurred by a sole proprietor, a corporation, a pass-through entity, or an entity subject to tax under §511
  • Regardless of whether the taxpayer is thinly capitalized

What limitations did the TCJA place on deductible business interest expense?

Since the passage of the TCJA, §163(j) now stipulates that the amount of deductible business interest expense in a tax year cannot exceed the sum of:

According to §163(j), “business interest” is defined as “any interest paid or accrued on indebtedness properly allocable to a trade or business,” and “business interest income” is defined as “the amount of interest includible in the gross income of the taxpayer for the taxable year which is properly allocable to a trade or business.” Both terms exclude investment income.

Skyscrapers

Download: Section 163(j) Roadmap

Understand how the business interest expense limitation under Section 163(j) affects deductions, including a comparison of the final regulations to the proposed regulations.

Is the definition of “interest” for purposes of the §163(j) limitation on deductibility of business interest expense broader than the definition of “interest” for federal income tax purposes generally?

For purposes of the IRC §163(j) limitation on deductibility of business interest expense, “interest” includes amounts paid or accrued as compensation for the use or forbearance of money, but also includes amounts associated with arrangements that create indebtednesses in substance but not in form.

Included among the myriad items specified as interest under the regulations are:

  • Substitute interest payments (but only if the payment relates to a sale-repurchase agreement or a securities lending transaction that is not entered into by the payor in the ordinary course of the payor’s business)
  • Acquisition discount
  • Deductible repurchase premium
  • Amounts treated as interest under other provisions of the tax law
  • A portion of the payments on over-the-counter interest rate swaps (subject to an exception)

The regulations do not expressly characterize debt issuance costs, loan commitment fees, guaranteed payments for the use of capital, or hedging income and expense as interest. However, the anti-avoidance rule contained in the regulations’ definition of interest clarifies circumstances under which hedging transactions and guaranteed payments for the use of capital are treated as interest for purposes of IRC §163(j).

[Bloomberg Tax & Accounting subscribers have access to more detailed insight into the limitations on business interest expense deductions. Interested in learning more? Request a demo.]

Currency

Download: Section 250 Final Regulations Roadmap

The Section 250 Final Regulations Roadmap will guide your organization and clients in 250 deductions and related definitions for taxable years beginning January 1, 2021.

Are there exemptions to the limitation under §163(j)?

Yes, under the small business exemption, the §163(j) business interest limitation does not apply to a taxpayer (other than a tax shelter) that satisfies the §448(c) gross receipts test for any tax year. Generally, the gross receipts test is satisfied if the taxpayer’s average annual gross receipts for the three prior tax years are less than or equal to $25,000,000 (indexed for inflation).

Building with columns

Subscriber-Only Resource: Portfolio 536-4th: Interest Expense Deductions

Read comprehensive coverage of the basic rules relating to the allowance of and limitations on deductions for interest expenses as set forth in the Internal Revenue Code and Treasury Regulations. Don’t have access? Request a demo.

How does the CARES Act impact §163(j)?

The CARES Act temporarily increased the ATI portion of the limitation from 30% to 50% of ATI for tax years 2019 and 2020 (with the ability to elect out of the increased limitation) and allowed taxpayers to elect to substitute 2019 ATI for 2020 ATI. Even with this additional relief, the limitation is likely to impact more businesses than originally thought when the provision was enacted.

Woman wearing mask in office

Watch on Demand: Coronavirus Impact on Tax Planning 

The CARES Act, enacted on March 27, 2020, provides emergency assistance to individuals, families, and businesses affected by the 2020 coronavirus pandemic. Learn about how it impacts taxes.

Key IRC Sections

Bloomberg Tax is pleased to offer the full text of the current Internal Revenue Code free of charge. This site is updated continuously and includes Editor’s Notes written by expert staff at Bloomberg Tax & Accounting indicating when a section has been repealed or when there is a delayed effective date, allowing you to see the current and future law. Links to related code sections make it easy to navigate within the IRC.


§163(j)

Interest

Tax Research and Practice Tools

From in-depth research and analysis to timesaving practice aids, Bloomberg Tax & Accounting has the resources you need to provide informed advice.

Access to this information requires a subscription to Bloomberg Tax & Accounting. Don’t have access? Request a demo.

Portfolio

PORTFOLIO

Portfolio 926-3rd: CFCs — General Overview

Review the rules for the U.S. federal income taxation of shareholders of controlled foreign corporations under Subpart F of the Internal Revenue Code.

Tools

PRACTICE TOOL

Tax Practice Series: Interest Expense

Examine the deductibility of seven major types of interest and understand complications related to the code’s general rule.

Increasing chart

PRACTICE TOOL

OnPoint: Business Interest Limitation Final and Proposed Regulations Business Entities

Download these slides on the final and proposed rules applicable to different business entities and assess the impact of the CARES Act.

Top