By Eric Street
With the majority of Tax Reform changes becoming effective for the 2018 tax year, this coming summer will prove important for taxpayers looking to stay on top of any planning opportunities that may arise. For some taxpayers, one of the larger changes will be the addition of a deductibility limitation on business interest (not including interest paid on floor plan financing). In the past, interest paid on any business loan was considered 100% deductible. Starting in 2018, a limitation was put in place for taxpayers whose average gross receipts exceed $25 million. The average is measured using the prior three tax years.
The allowable deduction is calculated based on 30% of your adjusted taxable income. This includes adjustments for interest paid, and a variety of other operating income/expense items. For years 2018 – 2021, the adjusted taxable income number will vary, similar to a company’s EBITDA (earnings before interest, taxes, depreciation, and amortization). For taxable years beginning after 2021, the number will change to more closely reflect EBIT (earnings before interest and taxes). Any interest expense not allowed can be carried forward indefinitely.
For S-Corporations, the non-deductible interest carries forward at the entity level and is triggered only once the entity generates enough income to absorb that excess. The same can be said for C-Corporations. For Partnerships, the excess amount is passed out to the owner, and carried forward at the individual level. The impact of this is that a partner’s basis is decreased for interest as it is incurred, even though it may not yet be deductible.
The test will be applied at the entity level, and on a combined basis, so related entities will be looked at as single-taxpayer for the purpose of the limitation. Real property and farming businesses do have the option of making an irrevocable election out of the limitation, however, as a result, the business will be forced to depreciate property with an asset life of 10 years or more using the alternative depreciation system. If your receipts are near that threshold, or approaching it, you’ll want to consider the affect disallowed interest may have on your taxable income for 2018, how you can maximize the allowed deduction, and whether you qualify and would benefit from electing out for the foreseeable future.
To learn more, please contact your own tax advisor at Apple Growth Partners for further guidance and information.