This is the fifth in a series of posts aimed at analyzing the new tax laws that go into effect on January 1, 2018. There will still undoubtedly be numerous clarifications and corrections coming out over time as the IRS issues Regulations and Technical Corrections, so this is just a preliminary understanding. Businesses will now face possible limitations on interest expense. Here we will look to see what these limitations are and the calculation involved.
The deduction for business interest will now be limited to 30% of the taxpayer’s adjusted taxable income. The amount of interest used in determining the 30% threshold is calculated net of any interest income included in the taxpayer’s gross income for the year.
Why was this implemented?
Given the increase of bonus depreciation to 100% and its application to used property as well, Congress sought to prevent double-dipping on deductions. By limiting the interest expense deduction, taxpayers are prevented from financing large amounts of fully expensed fixed assets and then also deducting the interest expense used to acquire the assets.
What calculation will be needed?
The main calculation will be determining the taxpayer’s adjusted taxable income. Adjusted taxable income is the business’s taxable income prior to including the following:
- Depreciation, amortization or depletion
- Business interest income and expense
- Any item of income, gain, deduction, or loss which is not properly allocable to a trade or business
- Net operating loss deductions
Once adjusted taxable income is determined, business interest income and expense are netted. The net of business interest income and expense is then compared to the adjusted taxable income to determine if it exceeds 30%.
Are there any exceptions?
Any real estate or farming business that elects to not follow the new 100% bonus depreciation rules will then also not be required to follow these interest limitation rules. Additionally, this area will not apply to small businesses who have average gross receipts of $25 million or less for the previous 3 taxable years.
What happens to any excess, nondeductible interest?
Generally, disallowed business interest may be carried forward indefinitely. For pass-through entities, the excess business interest will be passed through on the K-1. Partners or shareholders will then be required to determine their ability to deduct the interest in each subsequent year.
It is vital to stay up-to-date on how this new tax plan will impact your finances. At Malloy, Montague, Karnowski, Radosevich & Co., P.A. (MMKR), we strive to help all our clients create a solid strategy to protect their financial goals. If you are concerned about how this tax plan will affect your financial future, call our team today to schedule a consultation with one of our accountants.