CARES Act Helps Businesses with Change in Interest Expense Deduction for 2019 and 2020

by: Smith and Howard

April 6, 2020

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The Coronavirus Aid, Relief and Economic Security (CARES) Act, which was passed by Congress to help people and businesses facing financial hardship as a result of the COVID-19 pandemic, is temporarily changing some tax limits that were put in place by the Tax Cuts and Jobs Act (TCJA) of 2017.

Prior Interest Expense Deduction Rules

Section 163(j) of the Internal Revenue Code (IRC) created a limitation on the deduction of business interest expenses for tax years beginning after December 31, 2017. The law applied to interest on all business debt without a transition rule in place prior to the law. Deductions for business interest expense were limited to the sum of:

  • Business interest income
  • Floor plan financing interest expense
  • 30% of Adjusted Taxable Income (ATI)

Interest expense that had been disallowed as a deduction in the current tax year could be carried forward indefinitely to future years and would be considered as business interest paid, subject to any limitations applicable that year.

Interest Expense Deduction Rules under CARES Act

With the CARES Act, amendments have been made to Section 163(j), but these modifications are applicable for only the 2019 and 2020 tax years:

  1. The adjusted taxable income (ATI) limit for 2019 and 2020 has been increased from 30% to 50%. However, that increase does not apply to partnerships.
  2. Taxpayers can use the 2019 ATI for 2020 limits. This assumes income for the business will be lower in 2020 as a result of the COVID-19 pandemic, and the higher 2019 income therefore provides a greater deduction.
  3. For business partnerships, the limit increases to 50% for 2020 only. However, partners who had excess business interest (EBI) allocated to them in 2019 can deduct 50% of that amount in 2020, regardless of any other Section 163(j) limits.

Here is an example.

Assume that in 2019 a partner’s share of ATI is $300 and net interest expense of $190 before limitations.

  • In 2019, $90 of interest (which is the 30% limit on the $300 ATI) is deductible by the partnership with the remaining $100 allocated to the partner as EBI.
  • In 2020, the limit increases to 50%, and the partnership can then deduct $150 of interest (50% limit on the $300 ATI from 2019), with the remaining $40 allocated to the partner as EBI. Additionally, the partner can deduct $50 of the 2019 EBI outright.  The remaining $50 of 2019 EBI is subject to the rules in place currently.

Each partner may choose not to apply this modification.  It is currently unclear as to how these rules apply to tiered partnerships (i.e. which tier actually deducts the 50% EBI from 2019 in 2020.)

To get more information about how your business can address this modification to Section 163(j) of the IRC, please contact the tax team at Smith and Howard by filling out the form below.

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