New Rules on the Deductibility of Net Business Interest Expense

Does your business have debt with interest? Recent IRS and US Department of Treasury rule changes may affect you.

We have previously discussed changes to the rules surrounding Section 163(j), the deductibility of net business interest expense. Originally enacted as part of the Tax Cuts and Jobs Act (TCJA), and temporarily amended by the Coronavirus Aid, Relief, and Economic Security (CARES) Act, Section 163(j) was further amended on July 28, 2020 by the IRS and Department of Treasury. The Final Regulations and New Proposed Regulations provide definition and guidance on limitations on the deductibility of business interest expense (BIE).

Included in the new regulations are changes on adjustable taxable income (ATI), items that no longer qualify as business interest expense for the limitation, guidance for partnerships and K-1s, what qualifies as eligibility for electing real property trade of business (ERPTB), self-charging lending transactions and more.

What follows is a technical Top 10 recap of the new regulations. If you would like to speak with a Smith and Howard advisor, please use the contact form below.

1. The rules state that taxpayers should begin the ATI calculation with Tentative Taxable Income (TTI) rather than Taxable Income.  TTI is generally taxable income without regard to 163(j) limitations.

2. Capitalized amounts of depreciation/amortization (frequently under 263A but other code sections as well) are now added back in calculating TTI, regardless of the period in which capitalized amount is recovered through Cost of Goods Sold.

3. Items no longer treated as business interest expense (BIE) for purposes of the limitation are:

• Loan commitment fees
• Debt issuance costs
• Hedging transaction costs

4. Taxpayers with excess business interest expense (EBIE) carried forward from a K-1, should consider whether that business is an excepted business in the current year.

If it is excepted, EBIE from the prior year will not be treated as incurred in the current year and will be suspended until the partnership passes down excess business interest income (EBII) or excess taxable income (ETI). Examples include:

• 2018: Partnership is limited and passes EBIE to partner who cannot fully use the EBIE on their 1040 and has a carryforward to 2019.
• 2019: Partnership makes the real property trade or business election. The individual is not allowed to add back EBIE on line 2 of the Form 8990; that EBIE will be carried forward as EBIE until the partnership passes down excess business interest income EBII or excess taxable income (ETI).

5. The regulations clarify that, upon disposition of a partnership interest, any EBIE not deductible is added to the tax basis of the partner(s).  Additionally, the partnership inside basis is increased in essentially the same manner under 734(b) but would not be depreciable/amortizable.

6. The regulations confirm the 11-step process for allocating BIE. However, they provide that where a partnership determines that each partner has a share of the partnership’s allocable TTI, the partnership may bypass the 11-step process and simply allocate its deductible BIE and excess items in the same proportion.

7. The regulations confirm that rental real estate activities can elect be electing real property trade of business (ERPTB) if those activities rise to the level of Section 162 trade or business.

8. The Final Regulations also provide that a business that would be eligible to be an ERPTB if it did not qualify for the small business exemption can elect to be an ERPTB instead of an exempt small business. In the case of a partnership that the new rule allows to make an ERPTB election, the partners in the partnership may be benefited because the election allows them to characterize their partnership interests as belonging to an excepted business by looking through to the assets of the partnership, which is not permitted in the case of a partnership without an ERPTB election.

9. The New Proposed Regulations address self-charged lending transactions by providing that, if in a given taxable year a partner that lends to a partnership is allocated EBIE from the borrowing partnership and has interest income attributable to the self-charged loan, the lending partner would treat such interest income as an allocation of EBII from the borrowing partnership in such taxable year to the extent of the lending partner’s allocation of EBIE from the borrowing partnership in such taxable year.

10. Taxpayers can choose to follow proposed regulations rather than the final regulations through 2020 tax year as long as they apply the rules consistently.

This article was contributed by Slayton Gilmore, CPA, a Manager in our Tax Group. If you need the advice of a Smith and Howard tax professional, please complete the contact form below. Be sure to provide some background on your question so that we can direct your inquiry to the most appropriate tax professional.