IRS guidance addresses limitations on business interest expense

In Notice 2018-28, the IRS answered questions about the new business interest limit in Sec. 163(j), as amended by P.L. 115-97, known as the Tax Cuts and Jobs Act (TCJA), and asked for general comments on planned regulations.

Under amended Sec. 163(j), the deduction for business interest is limited to the sum of (1) business interest income; (2) 30% of the taxpayer’s adjusted taxable income for the tax year; and (3) the taxpayer’s “floor plan financing interest” for the tax year. Any disallowed business interest deduction can be carried forward indefinitely (with certain restrictions for partnerships). “Floor plan financing” refers to indebtedness financing the acquisition of, and that is secured by, motor vehicles held for sale or lease.

The new limitation, which is generally effective for tax years beginning after Dec. 31, 2017, applies to all taxpayers except certain trades or businesses described in Sec. 163(j)(7) and taxpayers whose average annual gross receipts for the preceding three tax years don’t exceed $25 million.

In the notice, the IRS stated the regulations would apply the business interest limitation rules at the level of the consolidated group (as defined in Regs. Sec. 1.1502-1(h)). The Service anticipates the regulations will not include a general rule treating an affiliated group that does not file a consolidated return as a single taxpayer for purposes of Sec. 163(j).

The IRS also said that it will allow the carryforward of business interest disallowed under the pre-TCJA version of Sec. 163(j) to the taxpayer’s first tax year beginning after Dec. 31, 2017. This business interest carried forward will be subject to potential disallowance under amended Sec. 163(j), in the same manner as any other business interest otherwise paid or accrued in a tax year beginning after Dec. 31, 2017. The regulations will further provide that business interest carried forward from a tax year beginning before Jan. 1, 2018, will be subject to the Sec. 59A tax on base-erosion payments in the same manner as interest paid or accrued in a tax year beginning after Dec. 31, 2017.

The regulations will provide that all interest paid or accrued by a C corporation on its indebtedness will be business interest within the meaning of Sec. 163(j)(5), and all interest on indebtedness held by the C corporation that is includible in gross income of the C corporation will be business interest income within the meaning of Sec. 163(j)(6). Regulations also will address whether and to what extent interest paid, accrued, or includible in gross income by a noncorporate entity, such as a partnership in which a C corporation holds an interest, is properly characterized as business interest to the C corporation.

The IRS also stated that the regulations will address the treatment of (1) earnings and profits of C corporations, which the IRS said will not be affected by the disallowance of business interest expense; (2) disallowed interest by partners in partnerships; and (3) floor plan financing.

• Notice 2018-28

— By Sally Schreiber, J.D., a JofA senior editor.