Since the recent signing into law of the Tax Cuts and Jobs Act on December 22, 2017, the CK team has received many inquiries about its effect on future tax burdens. According to a recent survey from HubSpot, 88.5% of small businesses don’t understand the full impact of the tax bill. It’s apparent that business owners are seeking more clarity. As your trusted business advisors, we hear you loud and clear. To help you get through this transition, we will be posting our latest insights into the effects of the new law. You can subscribe here to receive our weekly email updates.
This week we are examining a provision in the new law that could cause a tax increase – the new limitation on business interest.
Let’s start with businesses NOT subject to these new provisions:
- Any business with average gross receipts over the prior three years of less than $25 million. Keep in mind that IRS rules will require you to aggregate businesses with similar ownership for purposes of determining if this limitation has been met.
- An employee
- Any business which furnishes or sells certain types of energy
- An electing farming business
- An electing real property trade or business
What is an electing real property trade or business?
A real property trade or business is “any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business.” The IRS will allow these real property businesses to elect out of the interest deduction limitation via an annual irrevocable election. The cost for doing so? The real property business must apply ADS depreciation rather than the usual MACRS methods, which means longer depreciable lives and limitations on bonus depreciation.
If your business is subject to the interest deduction limitation, the interest deduction cannot exceed the sum of:
- The business interest income for the tax year; plus
- 30% of the business’ adjusted taxable income for the tax year; plus
- Business floor plan financing interest for the tax year
Adjusted taxable income generally means the business’ taxable income without regard to:
- Business interest income or business interest expense
- Any net operating loss
- The qualified business income deduction
- For tax years beginning before January 1, 2022, any deduction allowable for depreciation, amortization or depletion.
Any business interest not deductible due to these limitations will carry forward to the following tax year.
Who does this effect?
We expect these provisions will impact our clients with multiple entities and large amounts of financed capital expenditures the most. Given that interest rates are expected to rise, this valuable interest deduction will need to be looked at in terms of how companies decide to finance and capitalize their operations.
Keep in mind that these rules apply for tax years beginning after December 31, 2017. If you have questions in the interim, please call us at 630-953-4900.