Business Interest Limitation Modifications

By Josh Lapierre April 1, 2020

Updated as of April 14, 2020

This article was updated on April 14 to include provisions in Revenue Procedure 2020-22, which allows for a qualifying taxpayer to make a late election or withdraw an election to be treated as an electing real property trade or business or electing farm business for purposes of the business interest limitation. The notice also describes the timing and manner in which a taxpayer elects to utilize the benefits related to business interest limitation under the CARES Act.

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As part of the major tax reform signed into law late December 2017, commonly known as Tax Cuts and Jobs Act (TCJA), certain businesses were required to limit their business interest deduction. (For a more detailed discussion, read this article: New Limitation on Interest Deductions for Businesses.) In general, the limitation disallows any interest expense that is in excess of 30% of adjusted taxable income plus business interest income. Adjusted taxable income for tax years 2018 through 2021 is taxable income increased by interest expense, depreciation, amortization, and depletion and excludes any item not allocable to the business. Beginning in tax years 2022, depreciation, amortization and depletion are not added back for purposes of computing adjusted taxable income. Any disallowed interest is carried forward indefinitely. The limitation is not applicable to certain small businesses.

The CARES Act makes two favorable modifications to the business interest limitation. First, the 30% is increased to 50% of adjusted taxable income for years beginning in 2019 or 2020. A partnership cannot use the increased 50% of adjusted taxable income for the 2019 tax year and must continue to use the existing 30% limit. For partners that were allocated disallowed interest in 2019 from a partnership, unless they elect out, in 2020 the partner will be able to deduct 50% of the limited interest and the other 50% will be subject to the existing rules. The second modification, and maybe of greater benefit, is for tax year 2020: The bill allows businesses to elect to use their 2019 adjusted taxable income to calculate their 2020 business interest limitation. This will be very beneficial for many businesses that are subject to the interest limitation and had endured negative economic impact in 2020. For short taxable years in 2020 the 2019 adjusted taxable income must be prorated by the number of months in the short taxable year over twelve. This modification will allow many suffering businesses to deduct more interest expense than prior law would have allowed. This additional interest expense may result in a greater tax loss and with the CARES Act’s new modification of net operating loss rules, will allow taxpayers the potential carryback of the loss to receive a refund based on the higher federal tax rate that applied prior to TCJA.

Revenue procedure 2020-22 gives businesses much needed relief and flexibility for making or revoking the election to be an electing real property trade or business or electing farm trade or business for the business interest limitations purposes. A taxpayer that wishes to revoke the election made on an originally filed return or wishes to make the election not made on the originally filed return for 2018, 2019, or 2020 will do so by filing an amended federal income tax return (or amended Administrative Adjustment Request (“AAR”) for certain partnerships). The amended return must include a statement and make the necessary adjustments for all returns impacted from the change. The amended return making or revoking the election must be filed by October 15, 2021. This provides businesses with much needed flexibility when considering the new changes to the tax life of qualified improvement property. An electing real property trade or business will be unable to take bonus depreciation on the qualified improvement property unless any existing election is revoked.

Revenue procedure 2020-22 also provides guidance related to the changes made by the CARES Act to the business interest limitation calculations. First, the guidance provides the timing and manner of how to elect out of using the 50% of adjusted taxable income for 2019 and 2020. For partnerships subject to the rules they may only elect out of the 50% limitation in 2020 because they must continue to use the 30% limitation in 2020. That election may be made on an amended tax return or amended AAR for certain partnerships. The election out is an annual election for 2019 and 2020. Second, partners in a partnership can deduct 50% of any excess business interest expense in 2020 carried over from 2019 unless the partner makes the election out. Third, a business may elect to utilize the 2019 adjusted taxable income for calculating the business interest limitation in 2020 simply by doing so (a separate election statement, etc., is not required). The election can be made on an amended 2020 tax return. Additional guidance is expected in the form of section 163(j) proposed regulations.

These changes related to the business interest deduction will provide more flexibility and less limitations for many businesses at a time when cash flow is crucial. 2019 returns already filed should be reviewed to consider any impact these changes may have. An amended return may be necessary and beneficial for the business and its owners. The bill does not address any other certain features of §163(j), such as the tax shelter rules which require tax syndicates to apply the business interest limitation rules regardless of the size of the company. The bill addresses short taxable years in 2020 but it does not discuss certain transaction such as a corporation joining or leaving a consolidated group or certain other M&A transactions.

For more information, please contact your BNN tax advisor at 800.244.7444.

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CHECK OUT OUR COMPREHENSIVE GUIDE TO THE TAX PROVISIONS OF THE CARES ACT.