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What is the Business Interest Deduction Cap and How Can Your Small Business Benefit?

November 29, 2022

Your small business could qualify for a special exception to the business interest deduction cap. Learn how you can benefit.

Attention small businesses…if your business has average gross receipts of $25 million or less (indexed for inflation this is $27 million for 2022), you can avoid the business interest expense limit. See if you qualify.

It starts with ATI – Adjusted Taxable Income

ATI is your business’ federal taxable income without counting the following:

  • Business interest income and expense
  • Income, deduction, gain or loss not properly allocable to a business activity
  • Net operating loss (NOL) deductions
  • The new deduction for up to 20% of qualified business income (QBI) from pass-through businesses
  • While this used to be added back, beginning in 2022, the allowable deductions for depreciation, amortization or depletion are no longer added back

What is net interest?

Net interest is the amount of business interest paid or accrued during the year minus the amount of business interest income for the year.

What is the interest expense limitation?

The Tax Cuts and Jobs Act (TCJA) limited a business’ annual net interest deduction to 30% of ATI beginning with 2018. Interest expense which is limited can be carried forward to the next taxable year.

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 over the prior 3 years of $25 million or less ($27 million for 2022) 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.

Picture this

For 2022, let’s say that The Gold 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 Gold Corp can deduct in 2022 is $350,000, or 30% of its adjusted taxable income plus the business interest income. The excess of $50,000 is carried forward to 2023. If however, The Gold Corp’s average annual gross receipts for the prior 3 years is less than $27 million, they won’t have any interest expense limitations.

Questions? Wondering if you qualify? Contact us.

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