For tax years beginning after 2017, the deduction for business interest expense cannot exceed the sum of the taxpayer's:
* Business interest income for the tax year;
* 30% of adjusted taxable income (ATI) for the year, or zero if the taxpayer's ATI is less than zero; and
* Floor plan financing interest expense (Sec. 163(j); Prop. Regs. Sec. 1.163(j)-2(b)).
The prior Sec. 163(j) rules, which covered so-called earnings stripping and denied a corporation's interest deduction for disqualified interest to the extent it had excess interest expense in a year that its debt-to-equity ratio was greater than 1.5 to l, have been repealed.
Note: Proposed regulations providing guidance for the Sec. 163(j) limitation were issued in November 2018 (REG-106089-18). These proposed regulations would be effective when finalized. However, taxpayers and their related parties may apply these rules to tax years beginning after 2017, if they are applied consistently.
The Sec. 163(j) limitation applies to any interest properly allocable to a trade or business. For corporations that are partners in a partnership (or members of a limited liability company (LLC) taxed as a partnership), the limitation applies first at the partnership level and again at the partner and shareholder level. It applies to both active and passive activities, but a rental real estate business can elect out.
The Sec. 163(j) limitation applies only to business interest expense that would otherwise be deductible in the current tax year (Prop. Regs. Sec. 1.163(j)-3(b)(1)).
Definition of business interest expense
For a C corporation, all interest income and interest expense are treated as properly allocable to a trade or business (Prop. Regs. Sec. 1.163(j)-4(b)(1)). An exception to this statement is provided for allocations made to excepted trades or businesses, as described in Prop. Regs. Sec. 1.163(j)-10.
For purposes of the Sec. 163(j) limit, business interest expense is defined as the following (Sec. 163(j)(5); Prop. Regs. Sec. 1.163(j)-l(b)(2)(i)):
Interest expense that is properly allocable to a nonexcepted trade or business: A nonexcepted trade or business is any trade or business that is not an excepted trade or business. Excepted trades or businesses are (1) the trade or business of being an employee; (2) any electing real property trade or business; (3) any electing farming business; or (4) any excepted utility trade or business (Sec. 163(j)(7); Prop. Regs. Sec. 1.163(j)-1(b)(38)).