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IRS Finalizes Rules on Business Interest Expense Deduction Limits

August 17, 2020

Recent guidance from the IRS clears up some confusion on changes to the business interest limitation under the CARES Act. Here’s what you should know.

Attention business owners…are you up to speed on changes to the business interest expense deduction limits? While the CARES Act introduced changes in March, the IRS has released additional changes that you’ll want to be aware of. Here are the details.

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, under section 163(j) of the tax code. 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.

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.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act generally increases the limit on deducting business interest to 50% of ATI for 2019 and 2020.

What has changed?

Recently issued guidance includes final and proposed regulations, modifying the business interest expense limitation. One of the big differences is that now all depreciation can be added back in the calculation. For manufacturing firms, the CARES Act rules adversely affected them because cost of goods sold depreciation was not an add back. That is certainly one of the favorable things that came out of the final regulations. The final regulations also address how to calculate the interest expense limitation, what constitutes interest for purposes of the limitation, which taxpayers and trades or businesses are subject to the limitation, and how the limitation applies to consolidated groups, partnerships, internationally and in other cases as well.

The guidance also provides a proposed revenue procedure with a safe harbor for operators of qualified residential living facilities. If approved, taxpayers engaged in a trade or business that manages or operates qualified residential living facilities can treat such trade or business as a real property trade or business solely for purposes of qualifying as an electing real property trade or business. Comments on this proposed procedure must be received no later than Monday, September 28, 2020.

Additionally, the guidance provides FAQs on the aggregation rules for determining a taxpayer’s gross receipts for purposes of the small business exception to the business interest expense limitation.

These regulations come in response to the IRS’ continued interest in responding to taxpayers’ concerns throughout the process of providing regulatory guidance under the TCJA. Many of the finalized provisions are intended to ease the burden of compliance with section 163(j).

Questions? Contact us.

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