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Disallowed business interest expense occurs when a business’s interest expenses exceed the limit set by the tax code. In such cases, the excess interest expense that cannot be currently deducted is considered disallowed. The treatment of disallowed business interest expense depends on various factors, and the Tax Cuts and Jobs Act (TCJA) introduced changes to the rules governing the deductibility of business interest. Here’s what typically happens.
Carryforward of Disallowed Interest
Disallowed business interest expense can be carried forward indefinitely under the TCJA, allowing businesses to utilize the deduction in future tax years when their taxable income supports it.
Strategic tax planning is essential to maximize the benefit of carrying forward disallowed interest and aligning it with future income projections.
Limitation on Business Interest Deduction
The TCJA introduced a limitation on business interest deduction, capped at the sum of business interest income, 30% of adjusted taxable income, and floor plan financing interest.
Businesses must carefully calculate their allowable interest deduction, considering the three components and ensuring compliance with the limitation rules.
Small Business Exemption
Small businesses with average annual gross receipts of $26 million or less may be exempt from the business interest limitation, offering greater flexibility in deducting their interest expenses.
Utilizing the small business exemption requires businesses to monitor their gross receipts and assess eligibility on an annual basis.
Special Rules for Partnerships
Partnerships allocate excess business interest expense to partners, who may carry forward their share of disallowed interest.
Partnerships should communicate effectively with partners about their share of disallowed interest and coordinate strategies for utilizing the carryforward.
Election to Opt Out
Certain businesses have the option to elect out of the business interest deduction limitation, but this decision may impact other tax considerations, such as depreciation deductions.
Making the election requires a careful evaluation of the overall tax implications and potential trade-offs associated with opting out.
Impact on Taxable Income
Disallowed business interest can increase the taxable income of the business in the current year, affecting the overall tax liability.
Businesses should consider the short-term impact on cash flow and explore strategies to mitigate the immediate tax consequences of disallowed interest.
Planning for Future Deductions
Businesses with disallowed interest can engage in proactive tax planning to optimize deductions in future years when taxable income allows for the effective utilization of the carryforward.
Strategic planning may involve timing deductions to align with anticipated increases in taxable income.
It’s essential for businesses to carefully manage their business interest expense and stay informed about the rules and limitations set by tax laws. Consulting with tax professionals can help businesses navigate these complexities, optimize their tax positions, and plan for the effective utilization of disallowed business interest deductions in the future.
Stay informed, stay compliant.
