There were a lot of provisions to the reform bill or Tax Cuts and Jobs Acts recently, reducing taxes for most business such as a change on corporate tax rate cut from 35% to 21% and deductions on qualified business income to a new 20% rate. The cost of the tax cuts was offset by the Congress through interest’s limits that can be used by businesses for deductions. Although the lower tax rates are good news for corporations, there is a significant negative effect that this business has to deal with as well. For one, the deductibility of business interest expenses has a broad limitation. The new rule makes interest expense exceed the adjusted earnings-based threshold because they weren't allowed to make interest deductions. This new change does not only affect corporations but also to all business types. If you’re a taxpayer who owns a business, you must take note of these changes.
What are the new limits?
Businesses will no longer be able to deduct business interest expenses starting this tax year 2018. Business interest expenses are any interest paid or accrued on indebtedness properly allocable to a trade or business that exceeds the sum of the following:
How is the limitation calculated?
Before this year’s 2018 tax laws were changed, taxpayers can generally deduct business interest although it is still subject to some exceptions. This current year 2018 will be different because there is now a 30% limit on the adjusted taxable income for a taxpayer’s deduction on his net business interest. If you want to know how much business interest you can deduct this year, adjusting your taxable income is necessary and that can only be done without including your:
There is no limitation on investment interest and the adjustment for depreciation, amortization, or depletion is only applicable through 2021. The Capital-intensive business for tax years starting the year 2022 has more restrictive limitation.
Also, note that there is no limitation on the deduction for floor plan interest or the interest on debt incurred in financing a dealer’s purchase of a motor vehicle inventory for sale or lease. However, if you have a business that has floor plan financing, you will not be eligible for the new 100% bonus depreciation deduction as far as your purchased assets are concern.
What are the exceptions to the rule?
If your business has average annual gross receipts of $25 million or less, the new business interest expense limitation is not applicable to you. You will know if this exception applies to you by averaging the three preceding taxable year’s gross receipts. On the other hands, some taxpayers can also be exempted from the new interest deduction limitation if they fall under the following:
How will the new limitation affect my business?
Your tax liability may be heavily affected by the new business interest limitation even to those who have a conservative financed business. In order to get an idea of how significant the limitation is, modeling your 2018 tax liability that includes the business interest limitation. Next, check the cost and benefits of electing for the limitation not apply to real estate or farming business. Lastly, take a look at your capital structure and see if the limitation has a potential effect on it. Note that the after-tax cost of debt financing will be increased because of the limitation. You may also use the preferred equity in lieu of subordinated debt in case there is a limit on the interest deduction.
