Julia Chirkova
The Internal Revenue Service (IRS) has released updated Frequently Asked Questions (FAQs) regarding the limitations on the deduction for business interest expense, as detailed in Fact Sheet FS-2026-14, which revises the previously issued FS-2025-09. This update addresses critical changes and clarifications stemming from significant tax legislation, including the Tax Cuts and Jobs Act (TCJA) of 2017 and the more recent "One, Big, Beautiful Bill Act" (OBBBA). The revised guidance aims to provide taxpayers with comprehensive information on navigating the complexities of Section 163(j) of the Internal Revenue Code, which governs these deductions.
Evolution of Business Interest Expense Deductions
Prior to the enactment of the TCJA, Section 163(j) primarily applied to specific interest paid or accrued by corporations. However, the TCJA brought about a substantial overhaul of this provision, fundamentally altering how businesses can deduct their interest expenses. Starting with tax years beginning in 2018, the TCJA introduced a general limitation on the deduction of business interest, capping it at 30% of a taxpayer’s Adjusted Taxable Income (ATI) for the respective tax year.
This limitation, however, does not apply universally. Businesses that meet certain size thresholds are exempt. Specifically, companies with average annual gross receipts of $25 million or less over the three preceding tax years are not subject to this limitation. Additionally, certain regulated utilities are also excluded from this rule, recognizing the unique operational and financial structures inherent in these industries.
Further nuances to the business interest expense deduction were introduced. Investment interest and interest on floor plans – the debt incurred by motor vehicle dealers to finance the acquisition of inventory for sale or lease – are explicitly exempted from the Section 163(j) limitation. This carve-out acknowledges the distinct nature of these financing arrangements and their critical role in specific business sectors.
The Impact of the CARES Act and Subsequent Legislation
The landscape of business interest expense deductions continued to evolve with the passage of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) in March 2020. This legislation brought further amendments to Section 163(j). In response to these legislative changes, the Treasury Department and the IRS issued final regulations concerning Section 163(j) in September 2020 and again in January 2021, aiming to clarify the application of the rules in the context of the pandemic-driven economic environment.
More recently, the "One, Big, Beautiful Bill Act" (OBBBA) has introduced additional changes and clarifications to Section 163(j). The updated FAQs specifically highlight these recent amendments, with the final two questions in the fact sheet dedicated to detailing the OBBBA’s impact on the Section 163(j) limitation.
Key Changes Introduced by the "One, Big, Beautiful Bill Act"
The OBBBA has brought about significant modifications and clarifications to Section 163(j), impacting how businesses calculate their deductible interest expenses. These changes are crucial for taxpayers to understand to ensure compliance and optimize their tax strategies.
1. Reintroduction of Depreciation, Amortization, and Depletion in ATI Calculation:
For tax years commencing after December 31, 2024, the OBBBA has amended Section 163(j) to allow for the add-back of deductions for depreciation, amortization, or depletion when calculating Adjusted Taxable Income (ATI). This represents a shift from the period between tax years beginning after December 31, 2021, and before January 1, 2025, during which these specific deductions were not permitted to be added back to taxable income for ATI calculation purposes. This change could potentially increase the ATI for many businesses, thereby expanding their capacity to deduct business interest expense.
2. Revised Definition of Motor Vehicle for Floor Plan Financing:
Effective for tax years beginning after December 31, 2024, the OBBBA has revised the definition of a "motor vehicle" for the purposes of determining floor plan financing interest. The updated definition now explicitly includes trailers and campers designed to provide temporary living quarters for recreational, camping, or seasonal use, and which are designed to be towed by or affixed to a motor vehicle. This expansion clarifies the scope of vehicles eligible for the floor plan financing interest exemption, potentially benefiting a broader range of recreational vehicle dealers.
3. Clarification on the Application of Section 163(j) to All Business Interest Expense:
The OBBBA has also provided a crucial clarification regarding the application of Section 163(j) to all business interest expense. Except for interest that is capitalized under Sections 263(g) or 263A(f) of the Internal Revenue Code, Section 163(j) applies regardless of whether any portion of the interest would otherwise be deducted or capitalized under mandatory or elective interest capitalization provisions. Consequently, business interest expense excludes any interest capitalized under these specific sections but includes all other business interest expense. It is important to note that these clarifications are not intended to represent a change in the Treasury and IRS’s established position but rather to codify existing interpretations.
4. Exclusion of CFC Income Inclusions from ATI Calculation:
For tax years beginning after December 31, 2025, the OBBBA amends Section 163(j) to exclude a U.S. shareholder’s Controlled Foreign Corporation (CFC) income inclusion items under Sections 951(a), 951A(a), and 78 (including associated portions of deductions) from the computation of ATI. As a direct result of this amendment, U.S. shareholders will no longer be permitted to increase their ATI by a portion of CFC income inclusions. This change renders the proposed regulations under Treas. Reg. § 1.163(j)-7(j), issued in September 2020, inconsistent with current law for tax years beginning after December 31, 2025. Taxpayers can no longer rely on these specific proposed regulations for those periods. The Department of Treasury and the IRS have indicated their intention to issue further guidance addressing these significant changes.
Impact on Excepted Trade or Business Elections
The OBBBA has also prompted discussions and guidance regarding elections to be treated as an "excepted trade or business." Notably, the OBBBA itself did not alter or clarify the existing rules for making such elections under Treas. Reg. sections 1.163(j)-9 and 1.163(j)-1(b)(15)(iii). However, in response to the legislative changes, Revenue Procedure 2026-17 has been issued to provide transition guidance. This guidance is particularly relevant for taxpayers who have previously made these elections but now wish to withdraw them in light of the OBBBA’s amendments to Sections 163(j)(8) and 168(k). This procedural update offers a pathway for businesses to adjust their tax positions based on the new legislative framework.
Broader Context and IRS Guidance
The updated FAQs are structured into several key sections, including General Information, Excepted Trades or Businesses, and Determining the Section 163(j) Limitation Amount. This comprehensive approach aims to cover the multifaceted aspects of the business interest expense deduction rules.
The IRS’s ongoing efforts to provide clarity on complex tax provisions like Section 163(j) underscore the dynamic nature of tax law. The agency emphasizes the importance of taxpayers staying informed about legislative changes and regulatory updates. Information regarding taxpayer reliance on guidance published in the Internal Revenue Bulletin and FAQs is available on IRS.gov, reinforcing the agency’s commitment to transparency and taxpayer education.
The evolution of Section 163(j) reflects a broader trend in tax legislation to influence corporate financial structures and incentivize specific economic activities. The continuous updates from the IRS indicate a strategic effort to adapt tax regulations to the changing economic landscape and legislative mandates, ensuring that businesses have the most current information to manage their tax liabilities effectively.
