A Matter of Interest: To Elect or Not to Elect the CARES Act Modifications to Section 163(j)

As a result of the TCJA, taxpayers’ ability to deduct their business interest expense (BIE) is now subject to a limitation. In an effort to provide liquidity to taxpayers, the CARES Act generally allows taxpayers to temporarily increase the limitation on the BIE deduction for taxable years beginning 2019 and 2020. Although the changes are intended to be beneficial, taxpayers should analyze their specific tax fact pattern to determine whether adoption of the changes will be beneficial or disadvantageous in their particular fact situation. In this alert we discuss:

• The rules governing the deduction of BIE under the TCJA,
• The related adjustments to those rules by the CARES Act,
• What should a taxpayer consider in determining whether to apply the adjustments provided by the CARES Act, and
• If a taxpayer chooses to apply the adjustments, the mechanics of doing so

Deduction of BIE under the TCJA

Prior to the TCJA, most taxpayers were able to deduct their BIE without any limitation. The TCJA changed that with the imposition of an entirely new limitation on the deduction for business interest for taxable years beginning after December 31, 2017. Specifically, a taxpayer’s deduction for BIE is limited (the section 163(j) limitation) to the sum of:

• Its business interest income for the taxable year,
• 30% of its adjusted taxable income (ATI) for the taxable year, and
• Its floor plan financing interest for the taxable year.

For taxable years beginning after December 31, 2021, ATI is equal to the taxpayer’s Tax EBIT, which is the taxpayer’s taxable income computed without regard to:

• Items of income, gain, deduction, or loss which are not properly allocable to a trade or business,
• Any BIE or business interest income,
• The net operating loss (NOL) deduction,
• Any deduction for under section 199A for qualified business income, and
• Other adjustments that are prescribed by Treasury Regulations.

For taxable years beginning before January 1, 2022, ATI is equal to the taxpayer’s Tax EBITDA, which is the taxpayer’s Tax EBIT without regard to any deduction allowable for depreciation, amortization, or depletion. Taxpayers for whom depreciation and amortization are significant expenses will, all other things being equal, have a materially lower Section 163(j) limitation in taxable years beginning after 2021.

Any BIE that exceeds the taxpayer’s section 163(j) limitation (disallowed business interest expense) is carried forward indefinitely and can be used in future years to the extent the taxpayer’s BIE for a year is less than its section 163(j) limitation for that year (section 163(j) carryforward). For a partnership, the section 163(j) limitation is applied at the partnership level. To the extent that the partnership is able to deduct its BIE, it includes the deduction in its computation of ordinary business income (or loss).  To the extent the partnership has disallowed business interest, it is allocated among the partners, in the same manner as the non-separately stated taxable income or loss of the partnership (the amount allocated is excess business interest expense or EBIE). There are complex rules governing the deductibility of EBIE…

https://www.alvarezandmarsal.com/insights/matter-interest-elect-or-not-elect-cares-act-modifications-section-163j