You probably knew it was coming. While the news headlines screamed about the drop in the corporate tax rate from 35 percent to 21 percent, you heard less about provisions of the Tax Cuts and Jobs Act that would be put into place to help pay for the hefty reductions in tax revenue.
The new limit on business interest deductions is one that you need to understand. Expected to raise $250 billion over 10 years, this provision makes drastic cuts to what used to be a 100 percent deduction for everything except investment interest. Rather than simplifying the tax code, it will complicate your 2018 income tax preparation if it applies to your business.
Who Is Affected?
If your company had less than $25 million in average gross receipts for the last three years, you are not subject to this new addition to the tax code. This threshold applies to the total gross receipts of all related businesses, so you can’t simply break down an enterprise into several, smaller legal entities to avoid the limitation.
Two groups of taxpayers may choose to opt out of the interest limitation: real property business owners and farming business owners. Should they elect to do this, their decision is irreversible, and forces them to use the alternative depreciation system. This applies to non-residential real property, residential rental property, and qualified improvement property for the former, and to assets with useful lives of more than 10 years (barns, land improvements, etc.) for the latter.
As for pass-through entities, that’s complicated. Basically, the interest limitation is applied at the entity level, which means there can be some complex calculations if you have an S corporation or partnership. We can help you understand the rules here.
Calculating the Deduction
Starting with the 2018 tax year, businesses subject to the new limitation can only deduct 30 percent of adjusted taxable income, which is taxable income that does not include:
- Non-business income.
- Business interest expense or income.
- Depletion, depreciation, and amortization.
- Net operating loss deductions.
- The new 20 percent business deduction that is computed based on Qualified Business Income (QBI). This is another element of the Tax Cuts and Jobs Act that requires some study. We can help you determine if you’re eligible.
What About Floor Plan Financing Interest?
Unlike real property and farming business owners, car dealership owners do not have to opt in or out of limitations on the business interest deduction for floor plan interest. They are automatically entitled to the full 100 percent deduction, as before. This applies to high-cost inventory such as cars, boats, trucks, and farm equipment. But if you are making use of the floor plan interest exclusion, you may not able to claim 100 percent bonus depreciation in that year – these limitations are complex and we are awaiting detailed regulations and interpretations to clarify these points. Please call us for specifics!
As you can see, the new limitations on business interest deductions are complicated. We’d be happy to help you determine exactly how they affect your company – and to provide guidance as you start planning now for 2018 income taxes.