Posted by Karen Munoz, EA

Limitations on Business Expense

Limitations on Business Expense

Almost every section of the tax code was changed by the 2017 TCJA, which also affected every taxpayer, including businesses. While some of these changes were positive (reduced tax rate), a few of them were not as they got rid of, or reduced available deductions. 

Business interest deduction was one of the many changes made by 2017 TCJA. With this act, all interest realized or paid by a business can be deducted as an ordinary business expense during the computation of taxable income. Subsequently, every form of business now has the limitation of interest deduction, which is up to 30% of the business's AGI

The deduction for business interest cannot be more than the sum of:

  • The business interest income of the taxpayer for the year

  • 30% of the taxpayer’s adjustable taxable income for the year, and

  • The financing interest for the floor plan of the taxpayer. This is the interest from vehicle dealers, which is entirely deductive with the new law. While property employed in business or trade has floor planning debt, it is not subjected to the 100% bonus depreciation provided the interest expense was deducted fully. 

For example, let us explore these: A business has its adjustable taxable income of $150,000, $3,000 in business interest income, and a business interest expense of $15,000. The company can deduct the entire $15000 business interest since this is below $48000 – the addition of $3,000 business interest income and 30% of the adjustable taxable income.

The application of the limitation on business interest is the same for partnership and C Corporations since this limitation is applied at the partnership or corporation level. The business interest deduction accounts for estimating the taxable income or loss for the partnership corporation before the income or loss is allocated to each shareholder or partner. 

For instance, consider a PYZ partnership owned by two people with equal shares, having $400 income and $120 interest expense. PYZ can deduct $120 in interest expense up to 30% of the adjustable taxable income ($120) and report ordinary business income of $280. With this, each partner has a distributive share income of $140.

Should the interest expense be above 30% of the adjusted taxable income, each partner will get the excess of business interest, which will not be carried forward. In the future, the partner might deduct their share of an excess partnership interest, which is against extra taxable income from a similar partnership where they generated the carry-forward interest. 

To estimate limitation on business interest, adjustable taxable income, you will start with taxable income and remove:

  • Gains, deductions, income and losses that do not apply to the trade or business

  • Interest expense for the business

  • Interest income for the business

  • NOL deduction (Net Operating Loss)

  • Amortization, depreciation or deduction from depletion

For small business owners, there are exceptions in which the business interest will not apply. For a company that passes the $25 million gross receipt test in any tax year, for instance, the limitation on business interest will not apply.

The limitation and calculation are applied equally for all entity types partnership, corporation and sole proprietorship. This business interest limitation, however, does not apply to some other business type like:

  • Employees: Services you perform as a worker are not classified as a business or trade for business interest limitation, which removes an employee's wage from being included as part of the AGI to know the limit.

  • Regulated Public Utility

  • Electing farming property business or trade

As evident, the changes from the TCJA on business interest expense deduction were quite complicated. The good news is that the exception on small business excludes lots of business limitations.



Karen Munoz, EA
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