IRS Releases New Proposed Business Interest Expense Guidance

Chris Gaetano
Published Date:
Nov 27, 2018

The IRS has issued proposed guidance for the Tax Cuts and Jobs Act's business interest expense limitation, outlining general rules and regulations, definitions of certain terms and special rules for certain entity types. The IRS issued the proposal while, at the same time, withdrawing a proposal on the measure that it had released earlier

Under the current proposal, for tax years beginning after Dec. 31, 2017, the deduction for business interest expense is generally limited to the sum of a taxpayer’s business interest income, 30 percent of adjusted taxable income and floor plan financing interest. Taxpayers will use new Form 8990, Limitation on Business Interest Expense Under Section 163(j), to calculate and report their deduction and the amount of disallowed business interest expense to carry forward to the next tax year. In contrast to the previous rules, the proposed guidance does not provide for the carryforward of any excess limitation. 

The proposed regulations generally apply to interest expenses that can be deducted without regard to the section 163(j) limitation. Interest expense that has been disallowed, deferred or capitalized in the current taxable year, of which has not yet been accrued, would not be taken into account for the purposes of this limitation. 

The proposed regulation provides that, with respect to C corporations, all interest paid or accrued by the firm is treated as business interest expense, and all interest received or accrued by the firm includible in gross income is business interest income, and "thus, all of a C corporation's interest expense would be subject to limitation" and "all of a C corporation's interest income would increase the C corporation's section 163(j) limitation, except to the extent such interest expense or interest income is allocable to [a trade or business excepted from these rules]." 

Consolidated groups generally would have a single limitation, while members of an affiliated group that does not file a consolidated return would not be aggregated for the purposes of applying the limit. Additionally, partnerships wholly owned by members of a consolidated group are not aggregated with the consolidated group for the purposes of the limit, a contrast with the previous code that allowed for all members of the same affiliated group being treated as one taxpayer for the purposes of the limit. 

In general, the IRS guidance says that, when it comes to partnerships, the limitation is applied at the partnership level, and any deduction for business interest expenses not disallowed under the new rules is taken into account in determining the "nonseparately stated taxable income or loss of the partnership." Under the proposed regulations, partner-level adjustments are not taken into account when determining the partnership's limit, but each partner's partner-level adjustments are taken into account as items derived directly by the partner in determining the partner's own limitation, an approach that "takes partner-level adjustments into account at the partner, rather than the partnership, level when determining the partner's ATI [adjusted taxable income.]" Individual partners calculate their ATI without regard to the partners' distributive shares of any items of income, gain, deduction or loss of such partnership. The partners' shares of excess taxable income, however, do count towards the calculation. To avoid double-counting, partners should include only business interest income from a partnership to the extent that business interest income exceeds business interest expense determined at the partnership level. Additionally, partners should not include their shares of the partnership’s floor plan financing for purposes of determining the partner’s annual deduction limitation for business interest expense. 
Similarly, in the case of any S corporation, the deduction limitation would be applied at the S corporation level, and any deduction for business interest expense would be taken into account in determining the nonseparately stated taxable income or loss of the S corporation. The IRS said that, "due to the fact that S corporations generally are required to make pro rata distributions of income, allocations of excess taxable income and excess business interest income would be made in accordance with the shareholders’ respective interests in the S corporation." 

Noting that there are generally no statutory provisions or regulations that address when a payment is debt versus interest, the IRS said that it drew upon case law to define interest in the proposal as "any amount paid or accrued as compensation for the use or forbearance of money under the terms of an instrument or contractual arrangement, including a series of transactions." This means that the proposed regulations would apply to interest associated with conventional debt instruments, as well as transactions that are indebtedness in substance although not in form. This would also include any amount treated as interest under other provisions of the tax code or other regulations, such as original issue discount, accrued market discount, and amounts with respect to an integrated transaction under §1.1275-6.  

Further, the proposed definition of interest would also include things that may not technically be interest but are closely related and affect matters such as economic yield or cost of funds. The IRS said this can encompass things like income, deduction, gain or loss from a transaction used to hedge an interest bearing asset or liability; a substitute interest payment made on a debt instrument under the terms of a securities lending or a sale repurchase transaction; certain commitment fees; and certain debt issuance costs. The proposal also contains anti-avoidance rules that treat as interest expense for purposes of section 163(j) an expense or loss predominantly incurred in consideration of the time value of money in a transaction or series of integrated or related transactions in which a taxpayer secures the use of funds for a period of time. 

The IRS said that the business interest expense limit does not apply to taxpayers whose average annual gross receipts are $25 million or less for the three prior tax years. This amount will be adjusted annually for inflation starting in 2019. Also excluded are certain trades or businesses, including performing services as an employee, electing real property trades or businesses, electing farming businesses and certain regulated public utilities. Taxpayers must elect to exempt a real property trade or business or a farming business from this limit.

Taxpayers may rely on the rules in these proposed regulations until final regulations are published in the Federal Register. Written or electronic comments and requests for a public hearing on these proposed regulations must be received within 60 days of publication in the Federal Register.

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