Business Interest Expense Limitation – Time to Take It Seriously
Robert Bell, CPA, Tax Manager
I’ve written about the provisions under IRC 163(j) before, but now is the time to take it seriously. Businesses are limited to the amount of interest expense they are allowed to deduct for tax purposes to 30% of Adjusted Taxable Income (ATI). The ATI calculation used to allow for the addition of depreciation and amortization before applying the 30% threshold. We did not see many businesses have this limitation come into play. Starting in tax year 2022 however, business can no longer add back depreciation and amortization in calculating their ATI, meaning the 30% limitation will be much lower moving forward. In our current interest rate environment, this could be concerning for many – especially with the large capital investments we’ve seen.
Farming businesses and agricultural cooperatives do have an option to make a one-time irrevocable election out of these rules, therefore they wouldn’t be limited on the amount of interest expense allowable to reduce their taxable income; however, this comes with a price. If the election is made, any property with a recovery period of 10 years or more for tax purposes must use the Alternative Depreciation System (ADS) rather than the General Depreciation System (GDS). The IRS specifies what useful lives are to be applied under both methods in the agricultural industry under IRS Publication 946. According to these guidelines, grain bins and agricultural equipment must use a 10-year life under ADS, while they are afforded a 7-year useful life under GDS. ADS essentially requires straight line treatment whereas GDS allows for other accelerated methods (declining balance). One other aspect of this is that if electing out of the 163(j) provisions, businesses will need to evaluate all of their current fixed assets and change any property that was being depreciated over 7 years under the GDS method to 10 years under ADS for the remainder of the useful life. Property that is already fully deprecation does not require any revisions.
Further, if electing out, businesses are no longer eligible to use bonus depreciation on 10 year or greater lived assets, which would now include grain bins and the associated equipment under ADS. Also, if any businesses have already been limited on their interest expense and have a carryforward on their tax return, these will be lost once the election is made. Remember, 100% bonus depreciation will begin to phase out in tax year 2023 unless congress extends it, but currently it will step down 20% each year moving forward until completely sunsetting after tax year 2026.
How leveraged is your company? What are your current interest rates? What kinds of capital projects are in the future? Will they require financing? What does your existing depreciation schedule look like and what methods are being used? What is your projected tax situation?
These are all great starting point questions as you consider the impact of this limitation. As always, we are here to help you navigate this change.