Limitation on Interest Deduction ( 13301)

Transcription

1 Limitation on Interest Deduction ( 13301) 1

2 Prior Law: Interest Expense Limitations 1. Interest paid or accrued is generally deductible subject to limitations. No deduction for the disqualified portion of OID on certain high yield discount obligations. No deduction for certain obligations not in registered form. Deduction limited for interest on indebtedness where a mortgage credit certificate has been issued. No deduction for personal interest (individuals only). No deduction for interest on debt for certain life insurance contracts. No deduction for interest relating to tax exempt income. 2. Interest may also be subject to capitalization under 263A(f) or 461(g). 2

3 Prior Law: Investment Interest ( 163(d)) 1. Deduction for investment interest is limited to net investment income (gross investment income less investment expenses other than investment interest expense). 2. Net investment income is only deductible in excess of 2% of AGI. 3

4 Prior 163(j): Earnings Stripping 1. Disallowance rule applies only to corporations that (a) deduct specific types of disqualified interest and (b) are leveraged beyond certain quantitative thresholds. 2. Disqualified Interest is interest paid or accrued i. To a related party (if related party is not required to include such interest in income), ii. To a non-related party if it is guaranteed a related party, or iii. To a REIT by its taxable REIT subsidiary 4

5 New Section 163(j) Replaces the earnings stripping disallowance rule with a limitation regime that generally applies to all taxpayers (not just domestic corporations) and all business interest (as later defined). Business interest now deducted only to the extent it does not exceed the sum of: business interest income 30% of adjusted taxable income floor plan financing interest 5

6 Definitions 1. Business Interest interest paid or accrued on indebtedness properly allocable to a trade or business. 163(j)(5). This excludes investment interest that is subject to 163(d). 2. Business Interest Income the amount of interest includible in gross income which is properly allocable to a trade or business. 163(j)(6). This does not include investment interest as defined in 163(d). 3. Trade or business specifically excludes ( 163(j)(7)): i. Performing services as an employee ii. Any electing real property trade or business (must be a business described in 469 iii. iv. (c)(7)(c), such as development, construction, acquisition, leasing, management, etc.) Any electing farm business The furnishing or sale of certain utilities (i.e., energy, water, sewage disposal, gas) 6

7 Definitions 1. Adjusted Taxable Income taxable income of a taxpayer computed without regard to ( 163(j)(8)): i. Item of income, gain, deduction or loss not properly allocable to a trade or business ii. Any business interest or business interest income iii. The amount of any 172 net operating loss deduction iv. The amount of any deduction under 199A v. From 12/31/17 until taxable years beginning before 1/1/22, any deduction allowable for depreciation, amortization or depletion 7

8 Definitions Floor Plan Financing Interest - interest paid or accrued on floor plan financing indebtedness, which is indebtedness used to finance the acquisition of motor vehicles held for sale or lease and is secured by such inventory. 163(j)(9)(A)-(B). Motor vehicles include (i) any self propelled vehicle designed for transporting persons or property on a public street, highway or road, (ii) a boat, and (iii) farm machinery or equipment. 163(j)(9)(C). 8

9 Example: Calculating the Deduction Limitation Note: Assume that the taxpayer has no floor plan financing interest Taxpayer has $80 business interest expense in year 1. Taxpayer has adjusted taxable income of $150 and business interest income of $20. Maximum interest expense deduction: $65 Business interest income: $20 30% of adjusted taxable income of $150: $45 $20 (business interest income) + $45 (30% of adjusted taxable income) = $65 Disallowed interest expense: $80 - $65 = $15 9

10 Application to Pass-Through Entities 1. The limitation is applied at the partnership level. 163(j)(4)(A)(i). 2. Special rules to prevent double counting of partnership income in computing a partner s interest limitation. 163(j)(4)(A)(ii). 3. Special rule for additional interest deduction by a partner if partnership has an excess amount of unused interest limitation. 163(j)(4)(B). 4. Similar rules generally apply with respect to S corporations (other than the rule addressing the carryforward of disallowed deductions). 163(j)(4)(D). 10

11 Double Counting Issue The adjusted taxable income of a partnership may allow for a business interest deduction to be taken at both the partnership and partner level, if the partner can include such amounts in its own adjusted taxable income. 11

12 Additional Deduction Limit Question: How to deal with a scenario where a partnership has less business interest expense than it is allowed to deduct (i.e., excess business taxable income)? Answer: The excess business taxable income is allocated to the partners in accordance with how they share non-separately stated partnership income and loss. 163(j)(4)(A) flush language. 12

13 Additional Deduction Limit Example Facts: ABC partnership is owned equally by XYZ Corp. and an individual ABC generates $200 of non-interest income and has $40 of business interest expense XYZ Corp. has no other income but has a $25 business interest expense that is separate from its interest in the ABC partnership Analysis ABC partnership has $20 of excess business interest limitation because it is allowed to deduct up to 30% of its $200 adjusted taxable income (i.e., $60). The $20 excess business interest limitation is allocated to the partners in accordance with the way the partners share nonseparately stated taxable income or loss of the partnership. Accordingly, XYZ Corp. is allocated $10 of excess business interest limitation. Therefore, XYZ can deduct $10 of its $25 business interest expense that it has separate from its interest in the ABC partnership. 13

14 Carryforward of Disallowed Business Interest Generally: Disallowed business interest is carried forward to the succeeding taxable year. 163(j)(2). Application in the case of a partnership: A partner s share of excess business interest can be deducted only in the next year that the partnership has excess taxable income (i.e., excess limitation). 163(j)(4)(B)(ii). This means the individual partner cannot deduct his share of the excess business interest if that partner has individual business interest limitation available. 14

15 Carryforward of Disallowed Business Interest Cont. Application in the case of a partnership continued: ii. A partner that receives a share of excess business interest from a partnership must reduce its basis in the partnership (not below zero) by such share even though partner cannot take a deduction in such year. 163(j)(4)(B)(iii)(I). iii. If a partner disposes of its partnership interest before it can utilize the interest expense, the partners basis in the partnership is increased by the amount of interest expense not yet utilized 163(j)(4)(B)(iii)(II). The special rules relating to carryforward of disallowed business interest of a partnership do not apply to S corporations. 163(j)(4)(D). 15

16 Exceptions & Miscellaneous Exception A taxpayer that meets the gross receipts test in 448(c) (i.e., average gross receipts over 3 year period ending with the prior taxable year doesn t exceed $25 million). 163(j)(3). Miscellaneous 381(c) is amended so disallowed business interest deductions are transferred to an acquiring corporation in an asset transfer. 381(c)(20). 16