By Kenneth H. Bridges, CPA, PFS March 2020
The Tax Cuts and Jobs Act (TCJA) legislation enacted in late 2017 reduced tax rates and added new deductions like the qualified business income deduction. However, to help pay for those goodies, other changes were enacted which restrict deductions. One example of such is the limitation on business interest expense.
For 2018 – 2021, the general rule is that the deduction for business interest expense is limited to 30% of “adjusted taxable income”, which is basically EBITDA. For 2022 and thereafter, the limitation becomes even more punitive, as the definition of “adjusted taxable income” basically changes to EBIT.
There are exceptions to the general rule for companies with average annual revenue (computed over 3 years) of $25 million or less (as computed aggregating related entities, and indexed for inflation) and also certain industries (most notably real estate if a proper election is made to accept slower depreciation, and also floor plan financing of auto dealers and regulated utilities). However, there are some potential gotchas in the exceptions. A “tax shelter” does not qualify for the small business exception; and the definition of tax shelter for these purposes would likely surprise most people, as it includes any flow-through entity where more than 35% of the losses are allocated to members who do not actively participate in management of the business.
It may be possible to plan around the interest expense limitation by using leasing arrangements or priority returns in lieu of loans from members. The key is to be aware of the potential limitation, as these rules can be a trap for the unwary.
Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP, an Atlanta-based CPA firm.
This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice. The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.