Tax Reform Series 29 – Limitation on Deduction of Business Interest


Plain Language of Change:

  • The deduction of interest paid or accrued on a debt incurred in a trade or business is limited regardless of the form the taxpayer’s business is organized (i.e., corporation, partnership, sole proprietorship, etc.) effective for tax years beginning after December 31, 2017
  • The deduction for business interest for any taxpayer is limited in any tax year to the sum of: 
    • business interest income of the taxpayer for the tax year;
    • 30 percent of the taxpayer’s adjusted taxable income for the year, including any increases in adjusted taxable income as a result of a distributive share in a partnership or S corporation, but not below zero; and
    • floor plan financing interest of the taxpayer for the tax year
  • A taxpayer may also elect to exclude from the limitation any real property trade or business as defined under the passive activity rules
  • Interest expenses paid or accrued in the electing real property trade or business is not business interest subject to the limitation. Once made, the election is irrevocable
  • If a taxpayer elects to exclude a real property trade or business from the business interest limitation, then the business must use the alternative depreciation system (ADS) for certain property. This includes any nonresidential real property, residential rental property, and qualified improvement property held by the electing real property trade or business
  • The limitation on the deduction of business interest does not apply to any taxpayer that meets the $25 million gross receipts test.
  • A taxpayer meets the small business test for the tax year if its average annual gross receipts for the three tax years ending with the prior tax year do not exceed $25 million, adjusted for inflation after 2018 
  • Any business interest not allowed as a deduction for the tax year under these rules may be carried forward and treated as business interest paid or accrued in the succeeding tax year
  • The interest may be carried forward indefinitely, subject to certain restrictions for partnerships and S corporations
  • In the case of a partnership or S corporation, the limitation on the deduction of business interest is applied at the entity level
  • Unlike other taxpayers, any disallowed interest of a partnership or S corporation is not carried forward to the succeeding tax year. Instead, the disallowed interest of the entity is treated as excess business interest that is allocated to each partner or shareholder

Detailed Analysis of Limitation on Deduction of Business Interest

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