The new business interest expense deduction is one of the Tax Cuts and Jobs Act (TCJA) changes that could have a significant effect on a business’s net income and increase a company’s tax liability.
About the Business Interest Expense Deduction
A business’s interest expense deduction for tax years after 12/31/17 could now be limited by tax law changes to the sum of:
- The businesses interest income
- 30% of the adjusted taxable income (book net income +/- all tax adjustment items)
- The floor plan financing interest (vehicle dealerships only)
Two things to note:
- There is no limitation to the deductibility of interest expense if an entity’s gross receipts are less than $25M
- Any non-deductible interest expense can be carried forward to future years indefinitely
Business Interest Expense Deduction Example
For 2018 XYZ Company had gross receipts of $30M, operating expenses of $10M, interest income of $2M and interest expense of $12M. This entity had no floor plan finance interest.
Previous Law
Under the previous tax law, XYZ Company’s taxable income would be $10M.
$30M gross receipts
+ $2M interest income
– $12M interest expense
– $10M other operating expenses
= $10M adjusted net taxable income.
New Law
Under the new tax law, XYZ Company’s adjusted taxable net income would be $17M.
$30 gross receipts
+ $2M interest income
– $5M interest expense
– $10M other operating expenses
= $17M adjusted net taxable income
Deductible interest expense is calculated by using the adjusted net income of
$10M x 30% = $3M + $2M interest income = $5M deductible interest expense.
The TCJA business interest expense deduction limited deductible interest expenses to only $5M, which resulted in a $7M increase to net adjusted taxable income. Using the highest 2018 individual income tax rate of 37%, the limitation of the deductibility of interest expense could result in an additional tax liability of almost $2.6M.
Impact on Businesses
The Tax Cuts and Jobs Act lowered tax rates for individuals and corporations but other changes, such as the business interest expense deduction limitations, are going to create challenges that business owners need to be aware of and plan for. There may be tax planning opportunities that could help maximize your business interest expense deductions in future years. Contact an Anders advisor with any questions and to find out more about other TCJA tax law changes.
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