The IRS released guidance (Notice 2018-28) on April 2 providing that the new limit on the interest deduction will be calculated at the consolidated group level and that all C corporation interest will be considered business interest. The guidance also provides that partners can use their share of excess business interest income from a partnership to calculate their deduction for business interest, and that taxpayers may still carry forward interest expense deferred under the old interest limitation rules.
The new interest limit was created by Tax Cuts and Jobs Act (TCJA) and is effective for tax years beginning after Dec. 31, 2017. Under the new version of Section 163(j), the deduction for net business interest expense in excess of business interest income is generally limited to 30% of adjusted taxable income (with some exceptions). For tax years beginning before Jan. 1, 2022, adjusted taxable income is similar to earnings before interest, taxes, depreciation and amortization (EBITDA). Afterward, adjusted taxable income includes depreciation and amortization.
Notice 2018-28 indicates how the IRS plans to address several issues in future regulations, giving taxpayers guidance on some of the basic questions. But taxpayers still must wait for regulations for many of the technical questions, as well as the mechanics for implementing some of the guidance offered in the notice. Details on the guidance are offered below:
The IRS said the regulations will allow taxpayers to use existing carry-forwards of deferred interest expense from the previous version of Section 163(j) in future years, even though the previous carry-forward rules have been repealed with the rest of the old version of Section 163(j). However, these carry-forwards will be subject to the new limit like any other business interest, and will also be subject to the new Base Erosion and Anti-Abuse Tax under the new Section 59A if otherwise deductible.
The regulations will provide that all interest expense and interest income of a C corporation will be considered “business” interest and therefore subject to the limit. This rule will not apply to S corporations, which can still presumably have investment interest expense that is not subject to the limit. The regulations will also address whether and to what extent interest income and interest expense flowing from a partnership to a C corporation is business interest income and expense, but did not offer how the question would be resolved. In addition, the disallowance and carry-forward of any interest expense under Section 163(j) will not affect when the C corporation reduces earnings and profits for the expense.
As expected, the regulations will ensure that the limit is applied at the consolidated group level, consistent with the legislative history. A consolidated group’s taxable income for determining adjusted taxable income will be its consolidated taxable income under Treas. Reg. Sec 1.1502-11, and intercompany obligations will be disregarded for purposes of determining the limitation. The regulations will not include a general rule treating an affiliated group that does not file a consolidated return as a single taxpayer.
The IRS also identified several other consolidated groups issues it planned to address, but provided no direction on how they would be resolved:
- Allocation of the limitation among group members
- Treatment of disallowed interest carry-forwards when a member leaves the group
- Treatment of existing disallowed interest carry-forwards of a member that joins a group
- Stock basis adjustments of a group member related to disallowed interest deductions
- Application of Section 163(j) to a group when one or more members conduct a trade or business not subject to Section 163(j)
The regulations will provide that a partner can use only the partner’s share of the partnership’s business interest income in excess of the business interest expense in a Section 163(j) calculation (not including “floor-plan” financing interest). From the statute itself, it was originally unclear whether the business interest income flowing through to a partner could offset any other business interest expense at the partner level.
The notice gives taxpayers more comfort around some of the uncertainties presented by the new rules. On the other hand, it largely confirms expectations based on the statute and legislative history. Many tricky outstanding issues remain unresolved, making planning difficult. Taxpayers who could be affected by the new limit in the current tax year should model out and consider the potential effects before making financing decisions.
For more information contact:
Washington National Tax Office, Grant Thornton LLP
+1 202 521 1532
Washington National Tax Office, Grant Thornton LLP
+1 202 521 1512
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