Business Interest Expense Limitation of Related Taxpayers

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One of the major revenue-generating provisions enacted in the Tax Cuts and Jobs Act (TCJA) is the business interest expense limitation (LMC TCJA Alert #7). An area of concern to many businesses is whether multiple companies will be treated as related to each other under a provision of the law that exempts small business taxpayers from this limitation.

 

A business is exempt from the limitation (thus, it may deduct all its interest) when its average receipts for the previous three years (for 2018, the test period is 2015 to 2017) are $25 million or less. But when the same taxpayer (or small group of taxpayers) owns several businesses, the receipts of all businesses under common control must be aggregated. Each member company references the combined total of the entire group to determine if it is deemed to have receipts exceeding $25 million (and is subject to the business interest expense limit).

 

Background

Starting in 2018, TCJA limits the business interest expense a company may deduct from its taxable income. The interest deduction is generally limited to 30 percent of the business's adjusted taxable income (the amount of interest income and certain financing of auto dealers also add to the allowed expense). The limitation is imposed on all business taxpayers, regardless of form, if average annual receipts exceeded $25 million over the prior three years. In 2019, an inflation adjustment raises that threshold to $26 million.

 

Related Taxpayers

When the same taxpayers own two or more businesses, they must consider whether the companies are treated as related to each other for purpose of combining their receipts toward the $25 million threshold. They are considered related if five or fewer owners together own more than 50% in multiple companies. Only the ownerships that are identical in each company are considered toward the more-than-50% test. As an example, Joe owns 40% of ABC Partnership and Maria owns the other 60%. Joe and Maria also own XYZ Partnership, in which Joe owns 60% and Maria owns 40%. Joe and Maria each own at least 40% in both companies, so the common ownership is 80%. The receipts of both companies must be combined to see if either meets the $25 million threshold.

 

Now change the facts so Joe owns only 25% of ABC Partnership and Maria 75%. In XYZ Partnership Joe now owns 75% and Maria 25%. Joe and Maria each own at least 25% in both companies. The common ownership is 50%, so the receipts do not have to be combined (exactly 50% is not more than 50%). Each company would look only at its own receipts to see if the $25 million threshold is met.

 

Implications

This relatively simple example becomes more complicated when there are more owners and more businesses involved. Family attribution rules and a special election for real estate may also come into play. Also, if all the entities are not prepared by the same tax preparer, taxpayers will have to coordinate with their accountants to determine the common ownerships and amount of gross receipts deemed applicable to each return for the $25 million test.

 

Contact your LMC professional to discuss if your businesses must be combined for the $25 million test. All our prior Tax Cuts and Jobs Act Alerts are available on the Updates page of our website.

 

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