Business interest expenses are not deductible under the new limitation under IRC SS163. This article examines the Tax implications of this limitation, as well as how partnerships can avoid the limitation. It also explores the reclassification of revenue from contracts for sale as business interest income. The article also provides an example of how to claim these deductions.
Limitation on deduction of business interest expenses under IRC SS163:
A new IRS rule will limit the number of interest expenses a business can deduct. This will be effective for tax years beginning after December 31, 2021. Specifically, the limit applies to business interest income and floor plan financing interest expense. Also excluded are deductions for depreciation, amortization, and depletion.
In general, the business interest deduction limitation is 30% of ATI. However, it is possible to meet the 30% threshold if you meet the SS448(c) test, which is a test of average annual gross receipts. This test is based on the average annual gross receipts of the three previous tax years.
A new section 163 has recently been enacted that limits the deduction for business interest expenses to 30 percent of Adjusted Taxable Income. Adjusted Taxable Income closely mimics the earnings of a business before interest, depreciation, and business interest income. This limited deduction carries forward until the business earns Excess Taxable Income. This new rule affects all businesses, except for excluded businesses, which may elect not to follow the new law.
The limits on the deduction for business interest expenses under IRC SS163/J were introduced with the passage of the TCJA. Before the TCJA, the amount of interest expense could be deducted by a business if the debt was valid and it was paid out of profits. However, there was a problem with the amount of deduction.
Tax implications of Section 163 limitation for partnerships:
The limitation under Section 163 affects partnerships in many ways. It limits the amount that a partnership can deduct from its BIE but allows the partnership to carry forward excess BIE indefinitely. This limitation applies to all taxpayers, including partnerships, but certain industries are exempt from its application on an elective or mandatory basis.
The limitation will be phased in for partnerships after Dec. 31, 2022. It will affect ATI and business interest expenses for the first time in the partnership’s tax year following the deadline. The limitation also applies to S corporations. The transition period for the limitation will be three years.
Under section 163, a partnership can only deduct a portion of the expenses related to financing the business, but not the total amount. This limitation does not apply to nonresident alien individuals and foreign corporations. For example, a partnership can only deduct interest paid on nonrecourse debts if it is related to its real estate business.
A partnership’s average gross receipts cannot exceed $25 million per year, which is the threshold for determining its status as a small business. Its average annual gross receipts must be under $25 million to qualify, indexed for inflation. To qualify as a small business, a partnership must pass more than three-quarters of its losses to its limited entrepreneurs.
Reclassification of revenue from contracts for sale to business interest income:
Under IFRS 15, revenue from contracts with customers is accounted for when the parties to the contract have agreed to perform their obligations and substantially all of the consideration is received. However, certain criteria must be met before revenue can be recognized. For example, the customer must not be in a position to repay the consideration and the contract must be terminated.
The entity may also recognize costs for the fulfillment of a contract. This type of expense may also be treated as variable consideration. The entity may need to adjust its amortization approach to account for these costs. A change in the business model may trigger a reclassification.
