DC Tax Flash: IRS Issues Guidance Package on Deduction Limit for Business Interest Expense

Tax Alert

The Internal Revenue Service (IRS) today issued final and proposed regulations under Internal Revenue Code section 163(j) on the deduction limitation for business interest expense. The IRS also issued additional guidance on this issue, including a proposed revenue procedure that would create a targeted safe harbor, and a set of FAQs on the small business exemption.

Final Regulations

The rules finalized today provide broad guidance on how to calculate the business interest expense limitation as modified by the Tax Cuts and Jobs Act (TCJA). For tax years starting after 2017, the TCJA generally limited business interest expense deductions to the sum of: the taxpayer's business interest income; 30 percent (or 50 percent, as applicable) of adjusted taxable income (ATI); and floor plan financing interest expense.

The IRS explains that the final rules include other major provisions that instruct on:

  • What constitutes interest for purposes of the limitation;
  • Which taxpayers and trades or businesses are subject to the limitation; and
  • How the limitation applies in consolidated group, partnership, international, and other contexts.

The 575-page text of the final regulations is posted here.

Proposed Regulations

The proposed regulations instruct on characterizing interest expense "associated with debt proceeds of partnerships and S corporations (passthrough entities), including where debt is used to fund distributions and debt proceeds of partners or shareholders allocated to the acquisition of an interest in a passthrough entity," the IRS notes.

The rulemaking includes additional provisions, which the IRS explains would:

  • Instruct taxpayers on applying a different computational method in determining certain adjustments to tentative taxable income, and rules under which certain dividends paid by regulated investment companies (RICs) may be treated by shareholders as interest income for purposes of section 163(j);
  • Limit taxpayers in applying the corporate look-through provisions to lower-tier entities for purposes of section 163(j)(7);
  • Provide rules clarifying the application of the limitation on the deduction for business interest expense in the context of (1) lending transactions between a partnership and a partner (self- charged lending transactions); (2) partnerships engaged in trades or businesses that are not passive activities and in which certain partners of the partnership do not materially participate; (3) publicly traded partnerships; (4) certain section 734(b) adjustments; and (5) tiered partnership structures;
  • Provide rules for how the business interest deduction limitation rules under section 163(j) apply to United States shareholders, as defined in section 951(b), of controlled foreign corporations, as defined in section 957(a), and to foreign persons with effectively connected income in the United States;
  • Provide guidance regarding the definition of real property development and real property redevelopment, and the definition of a syndicate for purposes of section 163(j) and section 1256; and 
  • Provide guidance under section 163(j)(10) regarding the treatment of excess business interest expense allocated to a partner in a taxable year beginning in 2019, and the election to use ATI from the last taxable year beginning in 2019 to determine a taxpayer's section 163(j) limitation for a taxable year beginning in 2020.

The 285-page text of the proposed regulations is posted here.

Proposed Revenue Procedure

Notice 2020-59 proposes a revenue procedure that creates a safe harbor "allowing taxpayers engaged in a trade or business that manages or operates qualified residential living facilities to treat such trade or business as a real property trade or business solely for purposes of qualifying as an electing real property trade or business," the IRS explains.

Comments are due by September 28, 2020.

The 14-page text of Notice 2020-59 is posted here.

Frequently Asked Questions (FAQs)

The IRS today also issued a set of 11 FAQs on the aggregation rules under section 448(c)(2) that apply to the exemption for small businesses under section 163(j). The FAQs pose and answer the following questions:

  • What aggregation rules apply when all entities considered for aggregation are corporations?
  • What is a parent-subsidiary controlled group?
  • What is a brother-sister controlled group?
  • What is a combined group of corporations?
  • How is ownership determined for purposes of a parent-subsidiary or brother-sister controlled group?
  • What are the aggregation rules that apply to partnerships, trusts, estates, corporations, or sole proprietorships?
  • How are the parent-subsidiary group rules different for partnerships, trusts, estates, corporations, or sole proprietorships?
  • How are the brother-sister group rules different for trades or businesses that are partnerships, trusts, estates, corporations, or sole proprietorships?
  • Are the rules that apply to a combined group under common control under section 52(b) the same as the aggregation rules that apply to corporations under section 52(a)?
  • How is ownership determined for purposes of a parent-subsidiary or brother-sister group under common control?
  • What are the aggregation rules that apply to affiliated service groups?

The full text of the FAQS is posted here.

The IRS issued a press release today on the guidance package that is posted here.

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