CARES Act Temporarily Rolls Back Business Interest Deduction Limitation

BOSTON -- Under the recently enacted Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), the limitation on business interest expense deductions previously enacted as part of the 2017 tax reform has been temporarily relaxed.

Just by way of refresher, prior to the enactment of the Tax Cuts and Jobs Act of 2017 (the “TCJA”), businesses generally could fully deduct their business interest expense. However, Section 163(j) of the Internal Revenue Code imposed on corporations certain “earnings stripping” limitations and disallowed corporations with debt-to-equity ratios greater than 1.5 to 1 to deduct certain interest. The TCJA replaced these rules with a new limitation that applies generally to all businesses, regardless of form, except businesses whose average annual gross receipts did not exceed an inflation-adjusted $25 million for the three preceding taxable years. Special rules apply to farming, real estate and utility businesses.

Under the new Section 163(j), the yearly amount of business interest expense a business can deduct is limited to 30% of its “adjusted taxable income” (“ATI”) for such year (plus the amount of its business interest income, if any). Any disallowed deduction can be carried forward indefinitely (though unused ATI may not be carried forward). For tax years beginning in 2018 through 2021, ATI is calculated by adding back allowable deductions for depreciation, amortization and depletion (similar to EBITDA). After that, these amounts aren’t added back in calculating ATI (similar to EBIT).

Of course, the application of Section 163(j) to partnerships and their partners is more complicated. Generally, the 30% of ATI limitation applies at the partnership level. However, to the extent that a partnership has business interest expense in excess of its 30% of ATI limitation, such excess is not carried forward by the partnership. Rather, the excess is allocated to the partners, whose ability to deduct such excess in subsequent years is limited by allocations of ATI not used to support the partnership’s deductions of business interest expense.

The CARES Act brings a few welcome, albeit temporary, changes to Section 163(j). Most notably, the limitation is increased from 30% to 50% of a business’ ATI for taxable years beginning in 2019 and 2020. In addition, a business can elect to use its 2019 ATI instead of its 2020 ATI to calculate its interest expense deduction limitation for 2020. For partnerships, the increased 50% of ATI limitation applies only for taxable years beginning in 2020. However, to the extent a partnership has business interest expense in excess of its 30% of ATI limitation in 2019, half of such excess allocated to a partner can be automatically treated as a deductible expense in the partner’s 2020 taxable year (unless the partner elects out of this treatment). The other half of such excess is treated is it normally would be and remains suspended until the partner receives allocations of ATI not used to support the partnership’s deductions of business interest expense.

As always, this summary is for informational purposes only and is not tax or legal advice. Always consult a professional tax advisor for advice in light of the taxpayer’s particular circumstances.

For more information on changes to the business interest deduction limitation under the CARES Act, please contact:

Benjamin Damsky
(617) 918-7084
BDamsky@BlaisTaxLaw.com

Christopher Bird
(617) 918-7086
CBird@BlaisTaxLaw.com