Tax News Update    Email this document    Print this document  

July 28, 2020

BREAKING TAX NEWS | IRS releases highly anticipated final and proposed regulations on IRC Section 163(j) limits on business interest expense deductions, along with related guidance

Today, the Treasury Department released final regulations (TD 9905) (the Final Regulations) and proposed regulations (REG-107911-18) (the Proposed Regulations) with guidance on the business interest expense limitation under IRC Section 163(j) (the Section 163(j) Limitation). The Section 163(j) Limitation was modified in December 2017 by the Tax Cuts and Jobs Act (TCJA), and in March 2020 by the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act).

With the regulations, the IRS issued Notice 2020-59, which creates a safe harbor allowing taxpayers that manage or operate qualified residential living facilities to be treated as a real property trade or business solely for purposes of qualifying as an electing real property trade or business. It also released FAQs on the aggregation rules that apply for purposes of the gross receipts test and determining whether a taxpayer is a small business exempt from the IRC Section 163(j) deduction.

The Final Regulations provide guidance on:

  • Items treated as interest expense and interest income for purposes of IRC Section 163(j)
  • The exclusion of certain small taxpayers and trades or business from the Section 163(j) Limitation
  • The application of the Section 163(j) Limitation to consolidated groups, partnerships, foreign corporations, trusts and other taxpayers (such as REITs)
  • The interaction of IRC Section 163(j) with other deferral, disallowance and capitalization rules
  • Ordering rules for taking into account previously disallowed interest expense
  • Elections for excepted trades or businesses and how to allocate interest expense, interest income and other items
  • Coordination of the Final Regulations with the provisions of the CARES Act

Significant changes in the final regulations, as compared to the former proposed regulations, include:

  • Narrowing the proposed scope of the items treated as interest income and expense to exclude commitment fees, debt issuance costs, and gains/losses from certain hedging transactions, except in cases of abuse
  • Permitting taxpayers to add depreciation, amortization or depletion allowances that are capitalized into inventory under IRC Section 263A to "tentative taxable income" when calculating adjusted taxable income (ATI) for tax years beginning before January 1, 2022
  • Precluding intercompany transactions and asset transfers to an acquiring corporation in an IRC Section 381(a) transfer from being treated as a "sale or other disposition"

The Final Regulations apply to the first tax year beginning 60 days after the final regulations are published in the Federal Register (i.e., January 1, 2021, for calendar-year taxpayers). An anti-avoidance rule applies to transactions entered on or after the date the Final Regulations are published in the Federal Register. Taxpayers may apply the Final Regulations to tax years beginning after December 31, 2017, so long as they consistently apply all of the Final Regulations.

The Proposed Regulations:

  • Include a substantially modified set of rules for applying the Section 163(j) Limitation to controlled foreign corporations (CFCs), including CFCs that are members of a "CFC group"
  • Clarify the application of IRC Section 163(j) to different partnership structures
  • Provide guidance under the CARES Act on excess business interest expense allocated to a partner in a partnership in a 2019 tax year, and the election to use ATI from the last tax year beginning in 2019 to determine a taxpayer's Section 163(j) limitation for a 2020 tax year
  • Provide rules for applying the Section 163(j) Limitation to foreign persons with effectively connected income

The Proposed Regulations generally are not retroactive, though taxpayers may choose to apply them to tax years beginning after December 31, 2017.

Tax Alerts on this guidance are forthcoming.