Limitations on Business Interest Expense

The introduction of Tax Cuts and Jobs Act signed by the President brings about many tax breaks for the businesses. However, while there are plenty of breaks, there are also some areas that will bring about challenges for certain type of businesses. One of such unfavorable rules is the limitation put on business interest expense. 

Throughout the past few years, the debt taken up by businesses has been on the rise primarily because of the low interest rates on offer. Moreover, before 2018, the interest expense payments were considered to be fully deductible. It is because of these reasons that the businesses preferred debt financing instead of equity to maximize their gains. 

The New Law

Under the new law, companies that have taken upon excessive debt will find themselves to be at a loss. This is because, from 2018, companies will be restricted regarding getting their interest expense deducted to a limit of 30% of the company's earnings before interest, taxes, depreciation, and amortization (EBITDA). 

The amount of interest expense higher than 30% will not apply to deduction. Moreover, the law will be extended further, and in 2022, the deduction will apply to the earnings before interest and taxes (EBIT) which means the depreciation and amortization charges will be deducted. However, some exceptions are subjected to this rule. These are:

• Any business that has less than $25 million in average gross receipts over the last three years
• Any business that exists as an employee
• Any business dealing with selling of different types of energy
• An electing real property business or trade
• Any electing farming business. This means that such a business would have to follow the alternative depreciation system over the course of recovery period of ten years or more. 
• Floor plan financing interest will not be subjected to this rule. This means any debt taken up for the financing of motor vehicles that are held for sale or lease.

The Impact of this New Law

Because of the introduction of this new law, there are a lot of positive changes that are expected to be seen. The complete deduction of the interest expense has been looked upon negatively by the Congress for quite some time. The reason behind this is that a limitation in the interest expense brings along the following benefits:

• Before the implementation of this law, most of the businesses were seeking to finance their businesses with the help of taking up debt rather than equity. This was primarily due to the fully deductible nature of the interest expense. Because of this excessive debt taking practice, more businesses were exposed to the risk of going bankrupt. Thus, removing the practice of a fully deductible interest expense will lead to a more stable nature of businesses and the balance between financing through equity and debt will be restored.
• As a result of the ease of debt taking practices before the introduction of this law, many big businesses were guilty of abusing the practice. This earnings stripping practice is expected to come to a halt once the new law is established.
• Businesses that do not have income and thus do not have to pay taxes are not expected to be affected by this law rather; the big businesses will be the ones that will have to face the brunt.
• More revenue will be earned. It is expected that in the first phase $171 billion will be earned in tax revenue whereas in the second phase, after 2022, $307 billion of tax revenue will be earned in ten years.  

The recent changes in the tax laws will greatly affect the position of businesses which is why it is imperative that all businesses acquire sufficient knowledge about how each law pertains to their filing. However, going through the tax reforms is not something that can be done on your own as there is a lot of material that you need to go through to fully understand the law.

Thus, it is advised to seek help from a Professional Tax Preparer who can simplify the whole process for you and can provide you guidance regarding the complete matter. So, contact a professional tax preparer today and see how the tax reforms will affect your business.