In REG-106089-18, the IRS proposed rules that would govern the new business interest limit in Sec. 163(j), as amended by the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97.
Under amended Sec. 163(j), the deduction for business interest is limited to the sum of (1) business interest income; (2) 30% of the taxpayer's adjusted taxable income for the tax year; and (3) the taxpayer's floor plan financing interest for the tax year. Any disallowed business interest deduction can be carried forward indefinitely (with certain restrictions for partnerships and partners).
The new limitation, which is generally effective for tax years beginning after Dec. 31, 2017, applies to all taxpayers, except certain trades or businesses contained in Sec. 163(j)(7) (excepted trades or businesses) and taxpayers (other than tax shelters) with average annual gross receipts that do not exceed $25 million.
The proposed regulations contain a broad definition of business interest. The IRS in the preamble to the proposed regulations says that it is providing a "complete definition of interest that addresses all transactions that are commonly understood to produce interest income and expense, including transactions that may otherwise have been entered into to avoid the application of section 163(j)."
The proposed regulations adopt the Sec. 162 definition of "trade or business" because Sec. 163 and its legislative history do not provide a definition of what activities constitute a trade or business, while "a large body of case law and administrative guidance" exists to interpret the meaning of trade or business under Sec. 162.
The proposed regulations cover the following subjects:
- Prop. Regs. Sec. 1.163(j)-1 provides common definitions used in the proposed regulations.
- Prop. Regs. Sec. 1.163(j)-2 provides general rules for computing a taxpayer's Sec. 163(j) limitation.
- Prop. Regs. Sec. 1.163(j)-3 contains ordering and other rules explaining the relationship of the Sec. 163(j) limitation and other provisions of the Code that affect interest.
- Prop. Regs. Sec. 1.163(j)-4 provides rules for C corporations (including real estate investment trusts (REITs), regulated investment companies, and consolidated group members) and tax-exempt corporations.
- Prop. Regs. Sec. 1.163(j)-5 explains how the disallowed business interest expense carryforwards of C corporations are treated.
- Prop. Regs. Sec. 1.163(j)-6 provides special rules for how partnerships and S corporations apply the Sec. 163(j) limitation.
- Prop. Regs. Sec. 1.163(j)-7 explains how Sec. 163(j) applies to foreign corporations and their shareholders.
- Prop. Regs. Sec. 1.163(j)-8 contains the rules for how Sec. 163(j) applies to foreign persons with effectively connected income.
- Prop. Regs. Sec. 1.163(j)-9 provides rules for elections for trades or businesses that are excepted from the rules as well as a safe harbor for certain REITs.
- Prop. Regs. Sec. 1.163(j)-10 explains how to allocate expense and income between nonexcepted and excepted trades or businesses.
- Prop. Regs. Sec. 1.163(j)-11 contains certain transition rules for applying the Sec. 163(j) limitation.
The proposed regulations also include provisions that make changes to other regulation sections to conform and coordinate them to the proposed regulations under Sec. 163(j).
Along with the proposed regulations, the IRS issued Rev. Proc. 2018-59 on Nov. 27, which provides a safe harbor allowing taxpayers to treat certain infrastructure trades or businesses as real property trades or businesses solely for purposes of qualifying as an electing real property trade or business under Sec. 163(j)(7)(B), which allows the business to not qualify as a trade or business under Sec. 163(j).