Ask the Advisor: Will Tax Reform Limit My Business Interest Expense in 2018?
Q. Will tax reform limit my business interest expense in 2018?
Possibly. If your average gross receipts for the past three years are $25 million or more, business interest expense may be limited for tax years 2018 through 2022. The gross receipts test must include all related businesses, so taxpayers cannot avoid the limit by setting up separate businesses. Fortunately, the Internal Revenue Service (IRS) does not impose this limit on businesses with less than $25 million in gross receipts.
An interest expense deduction is limited to the sum of (1) 30 percent of adjusted taxable income (roughly EBITDA), (2) business interest income and (3) floor plan financing interest. The excess is not deductible in the current year and carried forward indefinitely. A calculation starts with net taxable income or loss, and adds back depreciation, amortization, taxes and interest expense. Consider this example:
Taxable income = $50,000
Add back $40,000 of interest expense
Add back $10,000 of depreciation and amortization
Adjusted taxable income (ATI) $100,000
Multiply ATI by 30 percent = $30,000 allowable business interest expense
Carryforward = $10,000 (indefinitely)
Certain businesses in the real estate and farming industries may choose to make an election to not limit their interest expense, which is irrevocable and applies to all future years. If an election is made, the alternative depreciation system must be used, meaning no bonus or Section 179 depreciation. It’s important to consider the impact on future years before making this election.