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In its Franchise and Excise Tax Notice #20-16, Interest Expense Carryforward (Aug. 2020) (Notice #20-16), the Tennessee Department of Revenue (Department) provides guidance on the carryforward and utilization of business interest expense disallowed for Tennessee excise tax purposes as a result of the state's unique conformity rules with respect to the IRC Section 163(j) limitation on business interest expense (BIE) deductions for the 2018 and 2019 tax years.

Background

Effective for tax years beginning after December 31, 2017, the Tax Cuts and Jobs Act (TCJA) limits the deductibility of BIE under IRC Section 163(j) to the sum of: (1) the taxpayer's business interest income, (2) 30% of the taxpayer's adjusted taxable income (ATI) and (3) the taxpayer's floor plan financing interest. Additionally, the CARES Act further amended IRC Section 163(j) by increasing the ATI limitation from 30% to 50% for the 2019 and 2020 tax years.¹ Disallowed BIE is carried forward, subject to certain limitations.

Tennessee conforms to the IRC Section 163(j) limitation, as amended by the TCJA and CARES Act, for tax years beginning after December 31, 2017, and before January 1, 2020 (collectively, conformity years), and decouples from IRC Section 163(j) entirely for tax years beginning on or after January 1, 2020.²

Computation of business interest expense deduction

In its Franchise and Excise Tax Notice #19-18, Interest Expense Computation (Aug. 2019) (Notice #19-18), the Department first addressed Tennessee's excise tax law's conformity to IRC Section 163(j) and described the excise tax BIE deduction limitation calculation for taxpayers included within a federal consolidated group. In Notice 19-18, the Department stated that, for tax years beginning after December 31, 2017, but before January 1, 2020, Tennessee taxpayers that are members of a federal consolidated group must allocate the federal consolidated group's allowed federal BIE deduction among the group members that had business interest expense during the tax year. That is, to the extent a federal consolidated BIE limitation exists, the consolidated BIE limitation is allocated among consolidated group members that are Tennessee taxpayers on a pro-rata basis according to the amount of interest expense that each member paid to entities outside of the federal consolidated group. If a federal consolidated BIE limitation does not exist, a Tennessee BIE limitation does not exist. To the extent a Tennessee BIE limitation does exist, the Department acknowledged the existence of a carryforward attribute for disallowed business interest expense. Notwithstanding this acknowledgement, Notice #19-18 did not address the manner and period for which disallowed BIE could be utilized for Tennessee excise tax purposes.

Carryforward and utilization of disallowed business interest expense deductions

Notice #20-16 addresses the unanswered question in Notice #19-18 on the carryforward and utilization of disallowed BIE for Tennessee excise tax purposes. According to Notice #20-16, a Tennessee taxpayer that is a member of a federal consolidated group (federal group member) should allocate the federal consolidated group's BIE carryforward for the 2018 and 2019 tax years in the same way the federal consolidated group's BIE deduction was allocated for these tax years, as described previously and in Notice #19-18 (e.g., on a pro-rata basis for a federal group member that had BIE during the tax year).

Further, the Department advised that for tax years beginning on or after January 1, 2020, taxpayers may deduct the 2018 and 2019 disallowed BIE carryforwards to the extent they are deducted for federal income tax purposes, subject to the same limitations placed on the carryforward for federal income tax purposes by IRC Section 163(j). Tennessee's excise tax statutes do not provide for a distinct state carryforward and utilization time period, and the Department's guidance does not explicitly address whether disallowed BIE may be carried forward indefinitely, as it would be for federal income tax purposes.

For Tennessee audit purposes, and because the Tennessee franchise and excise return does not contain a carryforward schedule for the disallowed BIE, a taxpayer must maintain information sufficient to verify the amount of its 2018/2019 BIE carryforward taken. Such information should include (1) total interest expense before the IRC Section 163(j) limitation, (2) the amount of BIE deducted under the applicable year's IRC Section 163(j) BIE limitation, (3) the BIE carryforward available at the beginning of the 2020 tax year, (4) the amount of BIE carryforward deducted for federal income tax purposes by tax year and (5) the remaining balance of BIE carryforward by tax year. To assist in maintaining this information, the Department has released a worksheet that should be completed and retained but not included with the taxpayer's Tennessee franchise and excise tax return. See also the Department's Franchise and Excise FAQs, Are business interest expense carryforwards incurred during the 2018 and 2019 tax years deductible for excise tax purposes? If so, how do I track the carryforwards?, providing an illustration of a completed worksheet.

Implications

Tennessee taxpayers whose federal IRC Section 163(j) BIE deduction is limited must take into account the state's unique conformity to this provision for the 2018 and 2019 tax years as well as its subsequent decoupling from this provision starting with the 2020 tax year. In addition, and as noted, a Tennessee taxpayer should consider maintaining detailed records and information sufficient to verify creation of the disallowed BIE carryforward amount and subsequent utilization.

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ENDNOTES

¹ The CARES Act amendments to IRC Section 163(j) generally allow taxpayers to increase the 30% of ATI limitation on the BIE deduction to 50% of ATI for tax years beginning in 2019 or 2020, although taxpayers can elect not to apply the higher 50% of ATI limitation. In addition, these amendments allow taxpayers to elect to use their ATI computed for the 2019 tax year (in lieu of their ATI for the 2020 tax year which, due to the COVID-19 emergency, presumably would be much less) in calculating their IRC Section 163(j) BIE limitation for the 2020 tax year. For the 2019 tax year, Tennessee conforms to IRC Section 163(j) as amended by the CARES Act. See the Department's Franchise & Excise Tax FAQs — Does the CARES Act of 2020 impact the excise tax return?

² Effective for tax years beginning on or after January 1, 2020, for purposes of computing Tennessee net earnings or net loss, IRC Section 163(j), as amended, is applied as it existed and applied immediately before the enactment of the TCJA. See Tenn. Code Ann. Section 67-4-2006(a)(10).