On July 28, 2020, the Internal Revenue Service (IRS) issued final regulations (T.D. 9905) (the final regulations) concerning the limitation on the deductibility of business interest expense (BIE) under Section 163(j) of the Internal Revenue Code (the Code), as amended by legislation commonly referred to as the Tax Cuts and Jobs Act (enacted Dec. 22, 2017) and the Coronavirus Aid, Relief, and Economic Security Act (enacted March 27, 2020) (the CARES Act).
Section 163(j) generally limits the amount of BIE that can be deducted in a taxable year to the sum of (i) the taxpayer’s business interest income for the taxable year; (2) 30% of adjusted taxable income (ATI) for the taxable year; and (3) floor plan financing interest expense for the taxable year. However, under the CARES Act, the amount of BIE that is deductible for taxable years beginning in 2019 or 2020 is computed using 50% of the taxpayer’s ATI for the taxable year (or, with respect to taxable years beginning in 2020, at the taxpayer’s election using 50% of ATI for the immediately preceding year), unless the taxpayer elects to instead apply the 30% ATI limitation. Special rules apply to partnerships with respect to 2019 and 2020. The Section 163(j) limitation applies to all taxpayers, except for certain small businesses whose gross receipts are below a statutory threshold ($26 million or less for 2019 and 2020, adjusted annually for inflation) and certain enumerated trades or businesses. The amount of BIE not allowed as a deduction for any taxable year as a result of the Section 163(j) limitation is carried forward and treated as business interest paid or accrued in the next taxable year (i.e., it is carried forward indefinitely). Taxpayers must report their business interest and Section 163(j) limitation on IRS Form 8990, “Limitation on BIE Under Section 163(j).”
The final regulations adopt and modify proposed regulations (REG-106089-18) issued in December 2018 (the 2018 proposed regulations). The final regulations alter certain definitions from the 2018 proposed regulations, address exceptions to the Section 163(j) limitation and set forth rules regarding the application of the Section 163(j) limitation to various types of entities. For the most part, practitioners have lauded the taxpayer-favorable changes reflected in the final regulations.
Concurrently with the publication of the final regulations, the IRS issued additional proposed regulations under Section 163(j) (REG-107911-18) (the 2020 proposed regulations). On the same day, the IRS issued Notice 2020-59, 2020-34 IRB 1 (the Notice) and FAQs Regarding the Aggregation Rules Under Section 448(c)(2) that Apply to the Section 163(j) Small Business Exemption (the FAQs).
The final regulations generally are applicable to taxable years beginning on or after Nov. 13, 2020 (or in the case of the anti-avoidance rules, on Sept. 14, 2020). Taxpayers generally may apply the final regulations to earlier years, provided that they do so on a consistent basis. The same discretionary retroactivity generally applies to the 2020 proposed regulations.
A high-level summary of certain key provisions of the final regulations, the Notice, the FAQs and some aspects of the 2020 proposed regulations is available here.