By Lindsey Anderson, CPA
Manager, Tax Services
Each Thursday for the next few weeks, Sponsel CPA Group will present The Deep Dive, a closer look at individual aspects of the new tax law and how they might affect you or your business.
The Tax Cuts and Jobs Act introduced a new limitation to businesses for the deduction of interest expense for amounts paid or incurred after December 31, 2017.
Under the new law, the deduction for allowed business interest for any tax year cannot exceed the sum of the following:
- 30% of the taxpayer’s “adjusted taxable income” for the tax year;
- the taxpayer’s “business interest income” for the tax year; plus
- the taxpayer’s “floor plan financing interest” for the tax year.
In order to fully understand the calculation for the deduction limitation, we need to define a few terms:
- “Adjusted taxable income” is defined as the taxpayer’s taxable income with exclusions for the following:
- Items of income, gain, deduction or loss that aren’t properly allocated to the trade or business
- Business interest or business interest income
- Deductions allowed for depreciation, amortization or depletion for tax years beginning before January 1, 2022
- Net operating loss deductions
- Qualified business income deductions allowed under Code Section 199A.
- “Business interest income” is defined as interest which is included in the taxpayer’s gross income for the tax year that is properly allocated to the trade or business. Investment interest income does not constitute business interest income.
- “Floor plan financing interest” is defined as interest paid or accrued on debt used to finance the acquisition of motor vehicles held for sale or lease, and is secured by the inventory acquired. Examples of companies this would apply to are car dealerships, boat dealerships and farm machinery/equipment retailers.
Any business interest that isn’t deductible because of the business interest limitation is treated as business interest paid or accrued in the following tax year, and may be carried forward indefinitely.
Small Business Exception to the Business Interest Deduction Limitation
There is a small business exception to the limitation on deducting business interest expense. The limitation does not apply to a taxpayer whose average annual gross receipts for the three tax year periods ending with the prior tax year do not exceed $25 million.
Treatment for Partnerships and S-Corporations
The interest expense disallowance is generally determined at the tax filer level. However, a special rule applies to pass-through entities (e.g. partnerships and S-corporations), which requires the determination to be made at the entity level; for example, at the partnership level instead of the partner level.
While the limitations on the business interest expense deduction can be complex, Sponsel CPA Group is here to help you navigate how this will affect your tax outlook, and create a plan to minimize your tax exposure.
If you have any questions about tax reform changes, please call Lindsey Anderson at (317) 613-7843 or email email@example.com.
Click here for detailed article on the “Pass-Through Income Deduction”
Click here for detailed article on “Changes to Fringe Benefit Rules for Employers”
Click here for detailed article on “New Favorable Depreciation Provisions”
Click here for summary of “Key Provisions Affecting Individual Taxpayers”
Click here for summary of “Key Provisions Affecting Business Taxpayers”