The Tax Cuts and Jobs Act (TCJA) generally limits deductions for business interest to 30% of adjusted taxable income (ATI). This unfavorable provision was intended to generate revenue to offset tax cuts elsewhere in the TCJA.

On March 27, Congress passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act to provide financial relief during the novel coronavirus (COVID-19) pandemic. The new law generally increases the limit on deducting business interest to 50% of ATI for 2019 and 2020. This favorable change provides opportunities for business owners to file amended returns to recover some federal income taxes paid for 2019, if already filed. It could also lower your tax bill for 2019 and 2020 or create a net operating loss (NOL) that can be carried back five years (also a change made under the CARES Act).

Devil in the Details

The business interest limitation rules are complicated. Under the CARES Act, the deduction for business interest — unless the business elects out of the limitation — has generally been increased from 30% of ATI to 50% of ATI for tax years beginning in 2019 and 2020. Because of the economic downturn in 2020, many businesses could have higher ATI in 2019 than 2020. If that’s the case, you can elect to use 2019 ATI to calculate the 2020 ATI limitation. Business interest expense that’s disallowed under this limitation is carried over to the following tax year.

To complicate matters, for partnerships (including limited liability companies treated as partnerships for tax purposes), the 30% of ATI limitation remains in place for tax years beginning in 2019 but is 50% for 2020. Disallowed partnership business interest expense from a partnership’s 2019 tax year is allocated to partners and carried over to their 2020 tax years.

Unless a partner elects otherwise, 50% of his or her excess business interest expense (EBIE) from 2019 is deductible in the partner’s 2020 tax year without regard to the business interest expense limitation rules. The remainder is subject to the normal limitation rules, calculated at the partner level, for carried-over partnership business interest expense. Partnerships also can elect to use 2019 ATI to calculate the 2020 ATI limitation.

How to Reap the Benefits

For 2019 returns that have already been filed, you’ll need to file an amended return to recover excess taxes paid due to the 30%-of-ATI limitation. Some taxpayers may even generate an NOL by amending their 2019 return. Under another favorable provision of the CARES Act, for C corporations, NOLs for 2019 and 2020 may be carried back five years.

When filing a return for the 2020 tax year (or for yet-to-be-filed 2019 returns), you may apply the 50%-of-ATI limit when deducting business interest — if you qualify and you don’t elect out of the limitation. The liberalized deduction may lower your tax bill (compared to what you would have owed under prior law). In some situations, it may even generate NOLs for 2019 and 2020 that, for C corporations, may be carried back five years under the CARES Act.

What’s Right for Your Business?

As you can see, the rules for deducting business interest are complicated under current law. Our tax team can explain the modified rules under the CARES Act and help determine whether your business can benefit from the changes this tax year or by filing an amended return for 2019.