Long-awaited guidance issued on the business interest expense deduction limitation

The Internal Revenue Service (IRS) released the long-awaited final regulations under IRC section 163(j) that contain some good news for manufacturers and other taxpayers.

Upon preliminary review of the 575-page final regulations, it appears the IRS generally was responsive to taxpayer comments. For example, one of the rules in the proposed regulations that disproportionately impacted manufacturers was revised. The regulations narrow the scope of expenses considered business interest expense subject to the limitation, provide additional clarity and flexibility for real estate businesses, and simplify the treatment of business interest for certain small business owners.

All that said, the rules are still extremely complex and require careful study and analysis. And, as if almost 600 pages of final regulations wasn’t enough, the IRS issued another set of proposed regulations, which address various issues not covered in the previous guidance. The new proposed regulations provide rules for tiered partnerships, self-charged lending transaction between partners and partnerships, and debt-financed distributions, and several other areas. Lastly, the proposed regulations clarify the application of the changes to section 163(j) as made by the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

The final and new proposed regulations are generally effective for tax years beginning after the date that is 60 days from the date they are published in the federal register. However, taxpayers may choose to rely on the newly released regulations or continue to rely upon the initial set of proposed regulations (issued in December 2018) for taxable years beginning after Dec. 31, 2017, and before the aforementioned effective date. In either case, the regulations must be applied consistently, and barring certain exceptions, in their entirety.

This alert is a preliminary overview of some key areas in the final regulations. We will be providing additional information in the coming weeks and months as we analyze the new guidance in detail. We encourage you to contact your Baker Tilly advisor to discuss how these issues may affect your tax position.

Background

A key revenue raiser included in the Tax Cuts and Jobs Act (TCJA or Act) was the limitation of the business interest expense deduction for many taxpayers. Essentially, a limitation of 30% of adjusted taxable income (ATI) was placed on the amount of business interest expense that could be deducted in a given tax year. Broadly, ATI is the equivalent of earnings before interest, taxes, depreciation and amortization (EBITDA) for tax years through 2021, then EBIT for tax years thereafter. Any excess business interest expense would be carried forward and potentially deducted in the subsequent tax year (handled somewhat differently for certain types of taxpayers). The CARES Act, passed in March 2020 to stimulate the economy during the ongoing COVID-19 pandemic, increased this limitation to 50% of ATI for the 2019 and 2020 tax years for nonpartnership taxpayers.