IRC Section 163(j): What You Need to Know and Do
Smart approaches to minimize the impact of interest expense limitations.
01 November 2024
The limits imposed by IRC Section 163(j) can significantly impact businesses, especially those with high-interest expenses. Here’s a breakdown of the essential information and the steps you should take to mitigate its effects.What is IRC Section 163(j)?
It’s a tax code provision that limits the deductibility of business interest expenses. The formula for this limitation considers your business interest income, 30% of adjusted taxable income (ATI), and floor plan financing interest. This rule applies at the entity level, with special provisions for consolidated groups, partnerships, and controlled foreign corporations (CFCs).
Who is Affected?
Businesses with high leverage, those that operate across different jurisdictions, and companies that carry forward disallowed interest expenses are the most affected. Some businesses and taxpayers, however, are exempt from these limitations.
What Should You Be Concerned About?
1. Interest Expense Carryforward: Any disallowed business interest expenses (BIE) are carried forward indefinitely, which could lead to a prolonged deferral of deductions.
2. Anti-Avoidance Provisions: The law includes rules to prevent businesses from reclassifying expenses or using technicalities to evade limitations.
3. State-Level Complications: Different states apply Section 163(j) on a separate company basis, leading to inconsistent treatment across jurisdictions. Businesses need to be aware of how this could affect state tax filings.
How Can You Minimize the Impact?
• Evaluate the Current Situation: Assess the extent to which Section 163(j) is limiting your business interest deductions, both now and in future projections.
• Reclassify Expenses: Consider whether some interest-related costs could be deducted as regular business expenses, which might allow for full deduction.
• Restructure and Optimize: Review your business’s debt profile and explore ways to manage or reduce your interest expense, whether through capital structure changes or operational adjustments.
• Model the Tax Impact: Since restructuring affects not just interest deductions but other tax areas as well, you’ll want to model the federal, state, and international tax implications.
• Assess Efficiency Across Jurisdictions: For companies operating in multiple regions, ensure your debt structure is optimized, particularly in areas where consolidated tax filings don’t apply.
FAQs: Your Questions on Section 163(j) Answered
Q: How does the interest limitation work in practice?
A: The limitation is based on a formula: business interest income + 30% of adjusted taxable income + floor plan financing interest expense. If your total interest expense exceeds this amount, the excess cannot be deducted in the current year.
Q: What happens to disallowed interest expenses?
A: Disallowed interest expenses can be carried forward indefinitely, but this could lead to a buildup of deferred deductions that may take years to fully utilize.
Q: What should I consider for state tax purposes?
A: Many states apply Section 163(j) on a separate company basis, meaning the interest expense incurred by one member of a group may not be deductible if they don’t have enough taxable income to support it.
For more information, reach out to our Tax Team.
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