Section 163(j) limits deductions on business interest expenses. This limitation applies to all businesses with the exception of some small businesses.
Following revisions related to the Tax Cuts and Jobs Act of 2017, these deductions are increasingly limited. Adding to the perfect storm, the upward trek of interest rates in recent years means taxpayers face a larger tax burden related to interest but without any accompanying changes to the law.
What is Section 163(j)?
Taxpayers can generally deduct interest expense paid or accrued in the taxable year except if Section 163(j) limitation applies. If it does apply, their deductible business interest expenses for a year must be less than the combination of:
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Their business interest income for the tax year
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Thirty percent of the taxpayer's adjusted taxable income (ATI) for the tax year
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The taxpayer's floor plan financing interest expense for the tax year
Limiting the Limitation
A 2017 revision to Section 163(j) limited the taxpayer's ability to claim the deduction. In 2022, ATI calculations were now done without considering any deductions for depreciation, amortization, or depletion. The changes moved the ATI calculations away from earnings before interest, income tax, depreciation, and amortization (EBITDA) to earnings before only interest and income tax (EBIT). This EBIT-style calculation is less generous to taxpayers, resulting in fewer interest deductions.
Put another way, this revision can potentially decrease a taxpayer's interest expense deduction, resulting in a taxpayer owing thousands, if not tens of thousands, of dollars. Companies that carry significant debt are especially vulnerable.
Combine these revisions with the increase in interest rates in recent years, and taxpayers are now shouldering an increasingly larger tax burden. Congress hasn't made any provisions to adjust these numbers in response to high interest rates.
These changes make it all the more important that taxpayers plan ahead. While planning won't automatically reduce a tax burden, it does give a taxpayer time and space to find other avenues for reducing their tax liability.
If you need help, call Senior Partner, Tax Controversy Attorney, and former IRS attorney Brandon A. Keim at (602) 200-7399 or contact him online to discuss your options.
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