The One Big Beautiful Bill Act (OBBBA)made permanent the more generous earnings before interest, taxes, depreciation and amortization (EBITDA) computation of the business interest expense limitation under Section 163(j), which had previously expired for tax years beginning after 2021.
The Tax Cuts and Jobs Act (TCJA), enacted in 2017, amended Section 163(j) to limit the deduction of business interest expense to the sum of a taxpayer’s business interest income, floor-plan financing interest and 30% of its adjusted taxable income (ATI) for the year. The starting point for determining a company’s ATI for any given year is its taxable income, without regard to section 163(j). For tax years beginning before Jan. 1, 2022, any deduction allowable for depreciation, amortization or depletion was added back to tentative taxable income to arrive at ATI (essentially a tax basis EBITDA). However, for tax years beginning after Jan. 1, 2022, taxpayers had to compute ATI to include depreciation and amortization deductions (tax basis EBIT), which reduced the amount of ATI to which the limitation applied, resulting in a smaller deductible interest expense.
Floor-plan financing was defined in Section 163(j) as indebtedness used to finance the acquisition of motor vehicles held for sale or lease and secured by the inventory acquired. The term “motor vehicles” included any self-propelled vehicle designed for transporting persons or property on a public street, highway or road, boats, and farm machinery or equipment.
OBBBA’s impact
The OBBBA brings back and makes permanent the computation of ATI without regard to depreciation, amortization or depletion for tax years beginning after Dec. 31, 2024. Many businesses should benefit from the return to a tax basis EBITDA-based computation of ATI because it will generally increase the amount of interest deductible in any given year for companies with depreciation, amortization or depletion.
In addition, the bill modifies the definition of motor vehicles to include any trailer or camper that is designed to provide temporary living quarters for recreational, camping or seasonal use and is designed to be towed by, or affixed to, a motor vehicle. This change also is effective for tax years beginning after Dec. 31, 2024.
Grant Thornton Insight:
The modified definition of motor vehicles expands the floor-plan financing interest deduction to additional taxpayers or additional inventory of taxpayers that were partially covered under the definition. It allows taxpayers to deduct additional interest expense in the current year, but it comes with a cost. Taxpayers that deduct floor-plan financing interest as a result of this provision (rather than as a result of having enough business interest income or 30% of ATI) are not allowed to take bonus depreciation for assets placed in service during the year.
The bill also includes some other less favorable changes to Section 163(j), which are effective for tax years beginning after Dec. 31, 2025. The first is a new coordination provision that applies the Section 163(j) interest limitation to business interest expense without regard to whether the taxpayer would otherwise deduct that interest or capitalize it under an interest capitalization provision. However, this rule does not apply to interest required to be capitalized under Section 263(g) (for certain hedges) or under Section 263A(f) (construction of designated property).
Grant Thornton Insight:
Under the TCJA, many taxpayers started to have significant interest expense limitations. The limitation issue may have increased in 2022-2024 as interest rates climbed and the limitation on business interest deductions became more restrictive under the EBIT framework. Taxpayers in this situation were turning to elective interest capitalization strategies, which under prior rules applied before the application of the Section 163(j) interest limitation. This meant that taxpayers could recharacterize interest to another item that was not limited (e.g., inventory). This new rule effectively negates any benefit of elective interest capitalization. Even though the EBITDA framework for ATI returns in 2025, taxpayers will still want to consider whether they could accelerate large carryforwards or mitigate the impact of other large deductions on ATI in 2025 through interest capitalization planning in 2025.
The second less favorable change to Section 163(j) modified the definition for domestic ATI to exclude the following items, effective for tax years beginning after Dec. 31, 2025:
- Subpart F inclusions under Section 951(a)
- Section 956 inclusions
- Net tested income inclusions under Section 951A
- Section 78 gross-up amounts
- The portion of deductions allowed under Sections 245A(a) by reason of Section 964(e) and 250(a)(1)(B) and by reason of any of the above inclusions
This change will impact companies with controlled foreign corporations (CFCs) that have interest expense subject to Section 163(j) and could offset some of the benefits of the change back to EBITDA, as excluding these amounts from ATI will lower the amount of deductible interest expense.
Grant Thornton Insight:
While the exclusion of Subpart F, GILTI and Section 78 gross-up amounts from ATI in the OBBBA aligns with the final Section 163(j) regulations, it removes a favorable opportunity that many multinationals had relied on. Under the proposed regulations, taxpayers making a CFC grouping election could increase ATI by a portion of the excess taxable income (ETI) of their CFCs. Removing this may significantly limit interest deductions for multinational groups with substantial foreign earnings. Affected taxpayers should reassess debt placement and capital structure in light of the new limitations.
Interaction with Section 174A
The wide-reaching OBBBA includes many other changes that may affect a company’s taxable income – especially when there may be optional timing of taking items into account under transition rules. One such interaction that should be carefully considered is the effect of expensing domestic research and experimental expenditures under new Section 174A, which will reduce ATI unless the taxpayer makes an optional election to capitalize and amortize such expenditures. (Read more about the interaction with 174A in our recent article.)
Grant Thornton Insight:
The OBBBA provides elective transition rules for taxpayers to recover their unamortized domestic Section 174 costs from prior years, but until the IRS provides guidance it is unclear whether this recovery would be considered amortization for purposes of Section 163(j), such that it does not impact ATI in the year of recovery or a deduction that reduces ATI and potentially further limits interest expense deductions.
State and local impact
State and local (SALT) considerations are essential for comprehensive tax planning. Taxpayers should begin by identifying the states most relevant to their tax profile and assessing these states’ conformity policies with respect to Section 163(j).
The conformity question may be particularly challenging to analyze, because states have taken a variety of inconsistent and complex approaches to the treatment of this deduction. For example, rolling conformity states such as Illinois and New York follow a current Internal Revenue Code (IRC), automatically incorporating the OBBBA, and have consistently conformed to Section 163(j) ꟷ so they now use the EBITDA calculation for purposes of determining ATI. Other states, including Florida and North Carolina, conform to a version of the IRC prior to the adoption of OBBBA, and so use the prior version of Section 163(j) under the 2022-2024 version dictated by the TCJA, using an EBIT calculation to determine ATI. Finally, a group of states that includes California has either fully decoupled from Section 163(j) or reverted to pre-TCJA versions of that statute, essentially resulting in an unrestricted interest deduction.
Further complicating matters is that some states might change these policies prior to the 2025 tax filing season through special or general legislative sessions. For example, some states that currently follow the OBBBA version of Section 163(j) may consider reverting to the 2022-2024 version of Section 163(j) under the TCJA in response to revenue concerns. On the other hand, some states that maintained conformity to Section 163(j) in the past but now want to provide businesses a more expansive interest deduction could decide to eliminate the Section 163(j) limitation in its entirety.
Outlook
While many companies are likely pleased with the EBITDA change in the OBBBA, the other changes to Section 163(j) and the impact to a company’s ATI of other provisions in the new law should be carefully considered to maximize interest deductions under the new rules. While the effectiveness of capitalizing interest to mitigate the limitation is terminated in 2026, evaluation of other tax methods and elections may provide additional planning strategies to increase depreciation or amortization under the EBITDA framework going forward.
For more information, contact:
Washington, D.C.
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