July 14, 2025
Section 163(j) of the Internal Revenue Code, introduced as part of the Tax Cuts and Jobs Act (TCJA) of 2017, places limits on the deductibility of business interest expense. The purpose of this provision is to prevent excessive use of debt to finance business operations, which can erode the tax base and encourage risky financial behavior. At a high level, Section 163(j) limits the amount of business interest a taxpayer can deduct in a tax year to the sum of (1) business interest income, (2) 30% of adjusted taxable income (ATI), and (3) any floor plan financing interest.
During its effective period, the TCJA provided two different methods for calculating ATI: one applicable to tax years 2018-2021, and a more restrictive method applicable to tax years 2022-2024. The starting point for both methods was a company’s taxable income, which was then modified by adding back certain items as outlined in the table below.
|
Adjustment to Taxable Income |
2018-2021 |
2022-2024 |
|
Business interest expense |
X |
X |
|
Net operating loss deductions |
X |
X |
|
Section 199A deduction |
X |
X |
|
Depreciation, amortization, and depletion |
X |
For tax years 2018-2021, the calculation effectively followed an EBITDA-based approach, as depreciation, amortization, and depletion were added back to taxable income when computing ATI. Beginning in 2022, these add-backs expired, resulting in an EBIT-based calculation that further limited the amount of deductible interest expense.
Beginning in tax year 2025, the One Big Beautiful Bill Act (OBBBA) modifies the ATI calculation by reinstating the add-back for depreciation, amortization, and depletion. This change returns the calculation to an EBITDA-based approach, increasing the base against which the business interest deduction limitation is applied. As a result, many companies will be able to deduct significantly more interest expense than they would have under the EBIT-based calculation that would have applied without the enactment of the OBBBA.
A simple example is provided below to illustrate the impact of the new provision. The example assumes no net operating loss deductions or section 199A deductions for simplicity.
|
Sample Company Calculation |
Under TCJA (2022-2024) |
Under OBBBA (2025 and after) |
|
Taxable Income |
$1,000,000 |
$1,000,000 |
|
Business interest expense |
$650,000 |
$650,000 |
|
Depreciation, amortization, and depletion |
|
$450,000 |
|
Adjusted taxable income (ATI) |
$1,650,000 |
$2,100,000 |
|
% Limitation |
30% |
30% |
|
Allowable Deduction for Interest Expense |
$495,000 |
$630,000 |
|
Disallowed Interest Expense |
$155,000 |
$20,000 |
It is worth noting that disallowed interest expense in any given year can be carried forward indefinitely. Additionally, beginning in tax year 2025, the 163(j) limitation applies only to companies whose average gross receipts over the previous three tax years exceed $31 million.
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