Business Interest Deductibility – Seth Gilson, Partner, CPA

The 2017 Tax Cut and Jobs Act (TCJA) amended the rules for deducting business interest expense (BIE). In general, under the previous law a business could deduct any amounts paid or ac­crued for interest during the tax year. The TCJA added new limits and requires additional compu­tations in determining the amount of deductible business interest in a tax year, provides for the carryforward of non-deductible interest and allows certain businesses an option to opt-out of the law.

Interest is any amount paid, received, or accrued for the use of money. Business interest income means any interest includible in gross income for the tax year in which it is properly allocable to a trade or business. BIE is any interest paid or accrued that is properly allocable to a trade or business.

The TCJA limits business interest deductions and such deductions cannot exceed the sum of the following:

  1. Business interest income, plus
  2. 30% of the adjusted taxable income, plus
  3. Floor plan financing interest

Items 1 and 2 above apply to most businesses, where item 3 generally applies to vehicle and implement dealerships. The IRS issued a draft with instructions for Form 8990, which provides guidance in implementing the new law. See IRS.gov/DraftForms for examples.

The law excludes certain businesses from the limitations of 163(j) and provides others with an opt-out-option. Exclusions are available to businesses with average gross receipts of $25 million or less over the most recent three tax years. Opt-out options are available for a trade or business providing services as an employee, an electing real property trade or business, an electing farming business or certain utility business.

Under the electing farming business option, specified agricultural and horticultural cooperatives could elect out of the section 163(j) limitation. The election is irrevocable, prohibits the use of bonus depreciation, and requires use of the alternative depreciation system for property with a recovery period of ten years or more.

For non-electing cooperatives and other businesses, such as partnerships, the section 163(j) limitation is the taxpayer’s adjusted taxable income (ATI) plus business interest income. Another way to define ATI is EBITDA (earnings before interest, taxes, depreciation and amortization). It is important to note that for tax years beginning on or after Jan. 1, 2022, TCJA reduces the limitation by eliminating any add-back for depreciation and amortization. ATI will effectively become EBIT or earnings before interest and taxes.

What should your coop do? You need to begin gaming out the various scenarios your coop has encountered over the previous few years and try to anticipate where you think your coop is heading in future years. In the short run, the add-back of depreciation and amortization in the equation to derive ATI makes it more likely your coop will choose to stay under the 163(j) limitation. Beginning with fiscal years ending Dec. 31, 2022 the change in the calculation will make that decision more challenging and require scrutiny of actual results versus budget, future capital expenditures and need for debt financing and impact of commodity prices on line-of-credit borrowings.

Cooperatives that have significant investments in joint ventures, LLCs or partnerships will have to factor in the impact of the limitation from these pass-thru entities. Pass-thru entities must calculate the allowable amount of deductible interest at its level and then pass thru to each owner their proportionate share. In addition, pass-thru entities that have certain loss or deduction items, and gain or income items will be included in the calculation to derive allowable BIE at the owner level.

This topic reinforces the vastness and complexity of the TCJA and helps explain why the IRS is issuing draft forms and instructions a year after the law was passed. I hope that you appreciate the fluidity of the process and understand the need for continual discussions this year in making the right decision for your business.