On November 26, 2018, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) issued proposed regulations (Proposed Regulations) under section 163(j) of the Internal Revenue Code of 1986, as amended (the Code). The Tax Cuts and Jobs Act (the TCJA) amended “old” section 163(j) with an entirely new section 163(j) which operates to limit the ability of taxpayers to deduct business interest expense. In contrast to “old” section 163(j), new section 163(j) applies to all taxpayers and all interest expense deductions.
The Proposed Regulations are long (439 pages), comprehensive, broadly applicable and technical, addressing new section 163(j) by providing general rules and definitions. The regulations also contain transition guidance that permits amounts carried forward under “old” section 163(j) as disallowed disqualified interest to be carried forward and treated as business interest expense (to the extent such amounts otherwise qualify as business interest expense) that may be deducted subject to the application of new section 163(j). This legal alert provides an overview of the Proposed Regulations and certain high-level observations.
A public hearing on the Proposed Regulations is scheduled for February 25, 2019. Outlines of topics to be discussed at the public hearing and comments on the Proposed Regulations must be submitted within 60 days of publication of the Proposed Regulations in the Federal Register.
Generally, section 163(j) limits a taxpayer’s deduction for business interest expense to the sum of 30% of the taxpayer’s adjusted taxable income, the taxpayer’s current year business interest income, and certain floor plan financing interest expense (the Section 163(j) Limitation). Section 163(j) does not apply to certain small businesses and excepted trades or businesses (including certain real property, farming and regulated utility businesses). Amounts of business interest expense that cannot be deducted because of the Section 163(j) Limitation can be carried forward and treated as business interest expense in future years.
- The scope of the Proposed Regulations is expansive based on the very broad and comprehensive definition of the term “interest,” which not only parrots the case law definition but also sweeps in any expense or loss to the extent “predominately” incurred in consideration of the time value of money. For example, commitment fees, debt issuance costs, and guaranteed payments are treated as interest in specified situations.
- The Proposed Regulations generally provide that section 163(j) applies after the application of other provisions that subject interest expense to disallowance, deferral, capitalization or other limitation. The Proposed Regulations also include rules regarding the relationship of the Section 163(j) Limitation to other provisions of the Code impacting interest. However, the Proposed Regulations defer on the interaction of section 163(j) and section 59A (relating to the tax on the base erosion minimum amount) to expected guidance under section 59A.
- For consolidated groups, the Section 163(j) Limitation applies at the level of the consolidated tax return. In contrast to “old” section 163(j), there are no super-affiliation rules under new section 163(j).
- The Proposed Regulations include detailed section 163(j) rules regarding pass-through entities and their owners. In the case of partnerships and S corporations, the Section 163(j) Limitation generally applies at the entity level.
- Non-US entities with effectively connected income and controlled foreign corporations (CFCs) are subject to the application of section 163(j). The Proposed Regulations clarify the application of section 163(j) to non-US entities with effectively connected income, to CFCs and to United States shareholders of CFCs.
- The Proposed Regulations define excepted trades or businesses and offer guidance on the allocation of items of expense and income between excepted and non-excepted trades or businesses, adopting relative asset bases as the general method with several exceptions and special rules.