IRS has issued final regs on the Code Sec 163(j) business interest expense deduction that reflect changes made by the Tax Cuts and Jobs Act (TCJA, PL 115-97) and the Coronavirus Aid, Relief, and Economic Security Act (CARES Act, PL 116-136).
This article, the first of a three-part series, discusses terms whose definition and/or method of calculation in previously issued proposed regs has been changed by the final regs. Parts two and three of the series are available on Checkpoint.
Background. The TCJA provides that, for tax years beginning after Dec. 31, 2017, the deduction allowed for business interest for any tax year can’t exceed the sum of (Code Sec. 163(j)(1)):
- the taxpayer’s business interest income for the tax year; (Code Sec. 163(j)(1)(A))
- 30% of the taxpayer’s adjusted taxable income (ATI) for the tax year; plus (Code Sec. 163(j)(1)(B))
- the taxpayer’s floor plan financing interest (certain interest paid by vehicle dealers, see below) for the tax year. (Code Sec. 163(j)(1)(C))
The amount at (2), above (30% of adjusted taxable income), can’t be less than zero. (Code Sec. 163(j)(1))
The CARES Act temporarily increases the net business interest deduction limit from 30% of ATI to 50% for tax years beginning in 2019 or 2020, with special rules provided for partnerships.
In 2018, IRS issued proposed regs (“the proposed regs”) that reflected the changes made by the TCJA. See, for example, Proposed business interest regs: foreign corporations & shareholders and foreign persons with ECI.
Changes to definitions, etc. of terms. The final regs make the following changes to definitions, etc. of terms that were used in the proposed regs:
New term—”tentative taxable income.” Consistent with Code Sec. 163(j)(8), Prop Reg §1.163(j)-1(b)(1) defined ATI as the “taxable income” of the taxpayer for the taxable year, with certain specified adjustments. Thus, in calculating ATI, the proposed regs began with taxable income as the amount to which adjustments are made when calculating ATI. Prop Reg §1.163(j)-1(b)(37)(i) generally provided that the term “taxable income” has the meaning provided in Code Sec. 63, but for purposes of Code Sec. 163(j), is computed without regard to the application of Code Sec. 163(j) and the Code Sec. 163(j) regs. However, in some instances in the Code Sec. 163(j) regs the term “taxable income” is used to indicate the amount calculated under Code Sec. 63 for purposes other than calculating ATI.
To prevent confusion from using the term “taxable income” in different contexts (in determining ATI, and for purposes other than determining ATI), the final regs use a new term, “tentative taxable income,” to refer to the amount to which adjustments are made in calculating ATI. (Reg §1.163(j)-1(b)(43))
Change in calculation of ATI re certain depreciation, amortization. Prop Reg §1.163(j)-1(b)(1)(i) required, in the calculation of ATI, an addback to taxable income of deductions for depreciation, amortization, and depletion for taxable years beginning before January 1, 2022.
In general, Code Sec. 263A requires certain taxpayers that manufacture or produce inventory to capitalize all direct costs and certain indirect costs into the basis of the property produced or acquired for resale. Depreciation, amortization or depletion that is capitalized into inventory under Code Sec. 263A is recovered through cost of goods sold as an offset to gross receipts in computing gross income; cost of goods sold reduces the amount realized upon the sale of goods that is used to calculate gross income and is technically not a deduction that is applied against gross income in determining taxable income. (Reg §1.61-3(a), Reg §1.263A-1(e)(3)(ii)(I), and Reg §1.263A-1(e)(3)(ii)(J)) Thus, Prop Reg §1.163(j)-1(b)(1)(iii) provides that depreciation, amortization, or depletion expense capitalized into inventory under Code Sec. 263A is not a depreciation, amortization, or depletion deduction, that may be added back to taxable income in computing ATI.
IRS has reconsidered Prop Reg §1.163(j)-1(b)(1)(iii). Accordingly, under the final regs, the amount of any depreciation, amortization, or depletion that is capitalized into inventory under Code Sec. 263A during taxable years beginning before January 1, 2022, is added back to tentative taxable income as a deduction for depreciation, amortization, or depletion when calculating ATI for that taxable year, regardless of the period in which the capitalized amount is recovered through cost of goods sold. (Reg §1.163(j)-1(b)(1)(iii))
For example, if a taxpayer capitalized an amount of depreciation to inventory under Code Sec. 263A in the 2020 taxable year, but the inventory is not sold until the 2021 taxable year, the entire capitalized amount of depreciation is added back to tentative taxable income in the 2020 taxable year, and such capitalized amount of depreciation is not added back to tentative taxable income when the inventory is sold and recovered through cost of goods sold in the 2021 taxable year. (Reg §1.163(j)-2(h)(3))
The final regs allow taxpayers, and their related parties within the meaning of Code Sec. 267(b) and Code Sec. 707(b)(1), who otherwise rely on the proposed regs in their entirety under the “Applicability dates” rules below, to alternatively choose to follow Reg §1.163(j)-1(b)(1)(iii) rather than Prop Reg §1.163(j)-1(b)(1)(iii). (Reg §1.163(j)-1(c))
IRS also notes that Code Sec. 179 deductions are allowed to be added back as amortization under Reg §1.163(j)-1(b)(1)(i)(E). (T.D. 9905)
Certain adjustments to tentative taxable income in computing ATI under Section 163(j)(8)(B). Under the authority granted in Code Sec. 163(j)(8)(B), the proposed regs included several adjustments to taxable income in computing ATI to address certain sales or other dispositions of depreciable property, stock of a consolidated group member, or interests in a partnership.
Prop Reg §1.163(j)-1(b)(1)(ii)(C) provided that, if property is sold or otherwise disposed of, the lesser of the amount of gain on the disposition or the amount of depreciation, amortization, or depletion deductions (collectively, depreciation deductions) with respect to the property for the taxable years beginning after December 31, 2017 and before January 1, 2022 (such years, the EBITDA period) is subtracted from taxable income to determine ATI.
The final regs revise Prop Reg §1.163(j)-1(b)(1)(ii)(C) by eliminating the “lesser of” standard and requiring taxpayers to back out depreciation deductions that were allowed or allowable during the EBITDA period with respect to sales or dispositions of property.
However, IRS also recognizes that, in certain cases, a “lesser of” computation would not be difficult to administer. Thus, proposed regs issued contemporaneously with the final regs (the Concurrent NPRM) provide taxpayers the option to apply the “lesser of” standard, so long as they do so consistently. See Prop Reg §1.163(j)-1(b)(1)(iv)(E) of the Concurrent NPRM.
Prop Reg §1.163(j)-1(b)(1)(ii)(D) provides that, with respect to the sale or other disposition of stock of a member of a consolidated group that includes the selling member, the investment adjustments (see Reg §1.1502-32) with respect to such stock that are attributable to deductions described in Prop Reg §1.163(j)-1(b)(1)(ii)(C) are subtracted in the calculation of ATI.
The final regs consider the following issue: whether the application of Prop Reg §1.163(j)-1(b)(1)(ii)(C) and (D) to the same consolidated group member would result in an inappropriate double inclusion if the asset sale precedes the stock sale, and whether Prop Reg §1.163(j)-1(b)(1)(ii)(C) should continue to apply to a group member if the sale of member stock precedes the asset sale.
IRS determined that the application of Reg §1.163(j)-1(b)(1)(ii)(C) and Reg §1.163(j)-1(b)(1)(ii)(D) to the same consolidated group member would result in an inappropriate double inclusion, and that Prop Reg §1.163(j)-1(b)(1)(ii)(C) should not apply to a former group member with respect to depreciation deductions claimed by the member in a former group. Thus, Reg §1.163(j)-1(b)(1)(iv)(D) provides anti-duplication rules to ensure that neither Reg §1.163(j)-1(b)(1)(ii)(C) nor Reg §1.163(j)-1(b)(1)(ii)(D) applies if a subtraction for the same economic amount already has been required under either provision.
Definition of interest expense. Unlike the proposed regs, the final regs do not treat the following as interest: loan commitment fees (Reg §1.163(j)-1(b)(20)(iii)(G)(1)), debt issuance costs (Reg §1.163(j)-1(b)(20)(iii)(H)), and hedging transaction costs. (Reg §1.163(j)-1(b)(20)(iii)(E) and Reg §1.163(j)-1(b)(20)(iii)(F))
Applicability dates. Regs other than those under Code Sec. 382 and Code Sec. 1502. The “general regs”—i.e., the regs covered by T.D. 9905, other than those under Code Sec. 382 and Code Sec. 1502—are generally applicable to taxable years beginning on or after the date that is 60 days after the date the regs are published in the Federal Register. See, e.g., Reg §1.163(j)-1(c).
Taxpayers and their related parties, within the meaning of Code Sec. 267(b) and Code Sec. 707(b)(1), may apply the rules set forth in the general regs, in their entirety, to taxable years beginning after December 31, 2017, and before the date that is 60 days after the date the regs are published in the Federal Register, so long as the taxpayers and their related parties consistently apply those rules, and, if applicable, Reg §1.263A-9, Reg §1.263A-15, Reg §1.381(c)(20)-1, Reg §1.382-1, Reg §1.382-2, Reg §1.382-5, Reg §1.382-6, Reg §1.382-7, Reg § 1.383-0, Reg §1.383-1, Reg §1.469-9, Reg §1.469-11, Reg §1.704-1, Reg §1.882-5, Reg §1.1362-3, Reg §1.1368-1, Reg §1.1377-1, Reg §1.1502-13, Reg §1.1502-21, Reg §1.1502-36, Reg §1.1502-79, Reg §1.1502-90, Reg §1.1502-91 through Reg §1.1502-99 (to the extent they effectuate the rules of Reg §1.382-2, Reg §1.382-5, Reg §1.382-6, and Reg §1.383-1), and Reg §1.1504-4, to those taxable years. See, e.g., Reg §1.163(j)-1(c).
Alternatively, taxpayers and their related parties, within the meaning of Code Sec. 267(b) and Code Sec. 707(b)(1), may rely on the proposed regs’ version of the general regs, in their entirety, for taxable years beginning after December 31, 2017, and before the date that is 60 days after the date the regs are published in the Federal Register, so long as the taxpayers and their related parties consistently apply Prop Reg §1.163(j)-1 through Prop Reg §1.163(j)-11, and, if applicable, Prop Reg §1.263A-9, Prop Reg §1.381(c)(20)-1,Prop Reg § 1.382-1, Prop Reg §1.382-2, Prop Reg §1.382-5, Prop Reg §1.382-6, Prop Reg §1.382-7, Prop Reg §1.383-0, Prop Reg §1.383-1, Prop Reg §1.469-9, Prop Reg §1.469-11, Prop Reg § 1.882-5, Prop Reg §1.1502-13, Prop Reg §1.1502-21, Prop Reg §1.1502-36, Prop Reg §1.1502-79, Prop Reg §1.1502-91 through Prop Reg §1.1502-99 (to the extent they effectuate the rules of Prop Reg §1.382-2, Prop Reg §1.382-5, Prop Reg §1.382-6, and Prop Reg §1.383-1), and Prop Reg §1.1504-4, to those taxable years. Notwithstanding the preceding sentence, taxpayers applying the provisions in the notice of proposed rulemaking may apply Reg §1.163(j)-1(b)(1)(iii) in these final regs for taxable years beginning after December 31, 2017. (T.D. 9905)
Regs under Code Sec. 382 and Code Sec. 1502. With respect to Reg §1.382-2 and, if applicable, Reg §1.1502-91 through Reg §1.1502-99 (to the extent they effectuate the rules of Reg §1.382-2), and with respect to Reg §1.382-5 and, if applicable, Reg §1.1502-91 through Reg §1.1502-99 (to the extent they effectuate the rules of Reg §1.382-5), the regs apply to testing dates and ownership changes, respectively, occurring on or after the date that is 60 days after the date the regs are published in the Federal Register. See, e.g., Reg §1.382-2(b)(3).
The regs provide additional rules with respect to the regs under Code Sec. 382 and Code Sec. 1502, that are analogous to those contained in the above paragraphs that begin “Taxpayers and their related parties” and “Alternatively, taxpayers and their related parties.” Like the rules in those above paragraphs, these rules provide applicability rules for tax years that begin after December 31, 2017 and before the date that is 60 days after the date the regs are published in the Federal Register. (T.D. 9905; also see, e.g., Reg §1.382-2(b)(3))
References: For the post-2017 business interest deduction limitation, see FTC 2d/FIN ¶K-5420 et seq.; United States Tax Reporter ¶1634.
