8532 / Is business interest deductible when the business is a corporation?

Editor’s Note: The CARES Act increased the 30 percent limit, discussed below, to 50 percent for tax years beginning in 2019 and 2020.¹ All entities (corporations and pass-throughs) could elect to use 2019 ATI instead of 2020 ATI in determining the 2020 business interest expense deduction, which often increased the business interest deduction for businesses who experienced reduced income levels in 2020.² See heading below for information about making and revoking the election.

Under pre-2018 law, business owners were typically permitted to deduct interest expenses incurred in carrying on a trade or business (subject to limitations).³ The 2017 tax reform legislation generally limits the interest expense deduction to the sum of (1) business interest income, (2) 30 percent of the business’ adjusted taxable income (ATI) and (3) floor plan financing interest (see below).⁴ Businesses with average annual gross receipts of $25 million ($31 million in 2025) or less for the three-taxable year period that ends with the previous tax year are exempt from this new limitation (i.e., businesses that meet the gross receipts test of IRC Section 448(c)).⁵

Generally, the limit applies at the taxpayer level, but in the case of a group of affiliated corporations that file a consolidated return, it applies at the consolidated tax return filing level.

“Business interest” generally excludes investment interest. It includes any interest paid or accrued on indebtedness properly allocable to carrying on a trade or business. “Business interest income” means the amount of interest that is included in the taxpayer’s gross income for the tax year that is properly allocable to carrying on a trade or business.

“Adjusted taxable income” means taxable income computed without regard to (1) items of income, gain, deduction or loss not allocable to carrying on a trade or business, (2) business interest or business interest income, (3) any net operating loss deduction (NOL), (4) the deduction for pass-through income under Section 199A and (5) for years before 2022, any deduction for depreciation, amortization or depletion.⁶ For the purpose of the business interest deduction, adjusted taxable income is computed without regard for the deductions that are allowed for depreciation, amortization or depletion for tax years beginning after December 31, 2017 and before January 1, 2022.

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Planning Point: In a chief counsel memorandum, the IRS found that to determine the allowable business interest expense deduction, ATI for the year includes any adjustments required under IRC Section 481(a) because of a change in accounting method for depreciation. The taxpayer in question here filed a Form 3115 to change accounting methods for depreciation for certain property placed in service during the 2017 tax year. The taxpayer had classified the property as seven-year property and later determined that the property should properly be classified as five-year property. The taxpayer then changed from an impermissible to permissible method of depreciating the property, resulting in a negative adjustment for the year of change (the taxpayer elected to forgo additional first year depreciation under Section 168(k)). According to the non-precedential memo, that adjustment must be reflected in the business’ ATI for the tax year.⁷

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“Floor plan financing interest” is interest paid or accrued on floor plan financing indebtedness, which is indebtedness incurred to finance the purchase of motor vehicles held for sale or lease to retail customers (and secured by the inventory that is acquired).⁸

As a result of these rules, business interest income and floor plan financing interest are fully deductible, with the limitation applying to 30 percent of the business’ adjusted taxable income.

Unused interest expense deductions may be carried forward indefinitely.⁹

CARES Act Elections

The IRS gave businesses substantial flexibility in making and revoking elections related to business interest expense deduction under the CARES Act. A taxpayer could elect under Section 163(j)(10)(A)(iii) not to apply the 50 percent ATI limitation for a 2019 or 2020 taxable year (2020 only for partnerships).

A taxpayer permitted to make the election could elect not to apply the 50 percent ATI limitation by timely filing a federal income tax return or Form 1065 (or amendments) using the 30 percent ATI limitation. No formal statement was required to make the election. The taxpayer could then later revoke that election by filing an amended return or form using the 30 percent limit. Similarly, to use 2019 ATI for 2020, the taxpayer merely filed using 2019 ATI (and could then later revoke that election by filing a timely amended return or form).

Partnerships elected out of the 50 percent EBIE rule by not applying the CARES Act rule on their return, and could later revoke that election on an amended return or form.¹⁰