Tax Reform FAQs: Business Interest Expense Deduction
posted Mar 19, 2018 by Jade M. Toher CPA, MST in the Global Tax Blog
Did the Tax Cuts and Jobs Act affect the business interest expense deduction? We had a question come up on this during our recent webinar, “The Impact of Tax Reform on Businesses and Individuals.” Be sure to check it out if you haven’t already. For now, let’s address this question. Did the business interest expense survive tax reform?
Our viewer’s question
Q: Could you clarify the 30% business interest deduction and the annual gross sales safe harbor?
What is business interest expense?
This is the cost of interest that is charged on business loans used to operate the business; it is deductible as an ordinary business expense. The loan, for which you are incurring interest on, must be used to either purchase assets for the company or pay for business expenses.
You can deduct interest on business loans if you are legally liable for the debt, both you and the lender intend that the debt be repaid, and you and the lender have a true debtor-creditor relationship. However, business interest is subject to certain limitations as part of the new Tax Law.
30% business interest deduction
Under prior law, business interest expense was generally deductible in the year in which the interest was paid or accrued, the only exception being that corporations were subject to certain limitations under IRC Section 163(j), otherwise known as “the earnings stripping rules”.
The TCJA replaced the “earnings stripping rules” with new regulation that applies to all businesses, regardless of form, on the deductibility of net business interest expense that exceeds 30% of a taxpayer’s “adjusted taxable income.” The “adjusted taxable income” is something similar to EBITDA using taxable income as a starting point.
The revised code allows the deduction for net business interest expense of any taxpayer so long as it does not exceed the sum of the following for the taxable year:
- Business interest income,
- 30 percent of “adjusted taxable income,”
- Floor plan financing interest (business interest incurred to finance motor vehicle inventory held for sale or lease)
What is the annual gross sales safe harbor?
This is otherwise known as the “25 million gross receipts test.”
Businesses with average annual gross receipts of $25 million or less are exempt from the 30 percent limit. In a related group of entities, the aggregation rules apply in determining whether the $25 million gross receipts threshold is met or exceeded. If the group’s gross receipts, when aggregated, exceed $25 million, the 30 percent limitation is then applied at each separate entity.
Applying the deduction
For 2018, let’s say that The Blue Corporation has....
- $1,000,000 adjusted taxable income (after applicable modifications),
- $50,000 of business interest income,
- $400,000 of business interest expense (none of which is floor plan financing interest).
This means that the maximum interest expense that The Blue Corp can deduct in 2018 is $350,000, or 30% of its adjusted taxable income plus the business interest income. The $50,000 excess business interest expense will be disallowed as a deduction in 2018 and treated as interest expense paid or accrued in 2019, subject to the same limitations. Note that any disallowed interest expense is carried forward indefinitely to be used when the entity has excess taxable income.
Questions on the business interest expense deduction? Our Tax Services Team can help- call us today!