IRS Releases New Proposed Regulations: Not Your Father’s Section 163(j)

On Monday, November 26, the Treasury and IRS released a 439-page package containing proposed regulations under IRC section 163(j), which provides a limitation on business interest deductions. The Tax Cuts and Jobs Act of 2017 (TCJA) repealed “old” section 163(j), enacted an entirely new section 163(j) that applies to all taxpayers (not just domestic corporations) and all interest deductions (not just interest on related party debt) and tightens the limitation from 50 percent of adjusted taxable income to 30 percent of adjusted taxable income (ATI). For taxable years before 2022, ATI is defined similarly to the definition in old section 163(j), approximating tax EBITDA. There has been uncertainty as to how new section 163(j) applies to partnerships and controlled foreign corporations in combination with the TCJA’s numerous other new provisions (GILTI, BEAT, FDII, etc.).

In general, section 163(j) limits a taxpayer’s ability to deduct business interest expense. A taxpayer may deduct business interest expense up to the sum of its business interest income, plus 30 percent of its adjusted taxable income, and its floor plan financing interest. Any unused business interest expense (excess business interest expense) may be carried forward indefinitely and used in future years. Excepted trades or businesses may elect out of the application of section 163(j). These include certain real property or farming trades or businesses.

The regulations are very long, dense, and complex. The following is a high-level overview of some of the key features of the Proposed Regulations.

• Old section 163(j) Carryforwards: Interest expense disallowed under old section 163(j) and not used prior to the first taxable year subject to new section 163(j) is treated as a business interest carryforward ifthe interest expense satisfies the provisions of new section 163(j) and the Proposed Regulations.
• Adjusted Taxable Income (ATI): Taxable income is computed as if all business interest expense were deductible, followed by certain additions and subtractions. Treasury has asserted its authority under section 163(j)(8)(B) to provide for numerous additions and subtractions that are not found in the code. For example, the proposed regulations provide special rules regarding disposition of depreciated or amortized property, under which income from the sale of depreciated property may not increase ATI to the extent the depreciation was not deducted from ATI in a prior year.

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