Corporate Tax | Just Tax

Business Interest Limitation (§§ 163(j), 163(l))

This checklist guides practitioners through the business interest expense limitation under § 163(j), the disqualified debt instrument rules under § 163(l), and their coordination with Sections 267A and 59A. Use this analysis when a taxpayer has business interest expense and is a C corporation, partnership, S corporation, consolidated group, or U.S. shareholder of CFCs.

Step 1. Applicability of § 163(j) and the Small Business Exemption

"In the case of any taxpayer (other than a tax shelter prohibited from using the cash receipts and disbursements method of accounting under section 448(a)(3)) which meets the gross receipts test of section 448(c) for any taxable year, paragraph (1) shall not apply to such taxpayer for such taxable year." (Section 163(j)(3))

• Taxpayers subject to § 163(j). All taxpayers with business interest expense are subject unless they qualify for an exemption. The limitation applies to C corporations, partnerships, S corporations, consolidated groups, trusts, estates, and individuals with business interest. (§ 163(j)(1), Treas. Reg. § 1.163(j)-2(a))
  • The small business exemption is determined annually. A taxpayer may qualify one year and be subject the next.
  • Protective elections. An exempt small business IS permitted to make an election to be an excepted trade or business even though it is not subject to § 163(j). (Treas. Reg. § 1.163(j)-2(d)(1) and 1.163(j)-9(b))
• Gross receipts test. A taxpayer meets the § 448(c) gross receipts test if it has average annual gross receipts for the three prior taxable years of not more than the threshold amount. (§ 448(c)(1), IRS Fact Sheet 2025-9, Topic A, Q3)
  • The base amount is $25 million, adjusted annually for inflation.
  • The inflation-adjusted threshold for tax years beginning in 2024 is $30 million.
  • The inflation-adjusted threshold for tax years beginning in 2025 is $31 million.
  • For tax years beginning after 2025, see the instructions for the applicable income tax return for the current threshold.
• Aggregation rules for gross receipts. Gross receipts of multiple taxpayers are combined if they are treated as a single employer under the controlled group rules of Sections 52(a) or 52(b), under the affiliated service group rules of § 414(m), or under the rules of § 414(o). (§ 448(c)(2), IRS FAQs Regarding Aggregation Rules, Dec. 5, 2025)
  • For a partnership, more than 50 percent of the profit interest or capital interest constitutes a controlling interest.
  • For non-corporate, non-partnership taxpayers, apply the gross receipts test as if the taxpayer were a corporation or partnership, but treat the taxpayer as its actual entity type when applying Sections 52(a), 52(b), 414(m), and 414(o).
  • When aggregating, do not duplicate amounts by also including a share of partnership or S corporation gross receipts as your own gross receipts.
• Tax shelter exclusion. The exemption does not apply to a "tax shelter prohibited from using the cash receipts and disbursements method of accounting under section 448(a)(3)." (§ 163(j)(3))
  • A "tax shelter" includes three categories under § 448(d)(3).
  • Category 1 is any enterprise (other than a C corporation) if interests have been offered for sale in any offering required to be registered with a securities regulator.
  • Category 2 is any entity described in § 6662(d)(2)(C)(ii) (significant purpose is tax avoidance).
  • Category 3 is a "syndicate" under § 1256(e)(3)(B), meaning a partnership or other entity (other than a C corporation) if more than 35 percent of its losses during the taxable year are allocable to limited partners or limited entrepreneurs. (Treas. Reg. § 1.448-2(b)(2)(iii))
  • Gains or losses from the sale of capital assets or § 1221(a)(2) assets are NOT taken into account in the 35 percent syndicate test.
  • If an entity has NO loss for a taxable year, it is NOT a syndicate for that year.
• Annual election to avoid syndicate status. Under Treas. Reg. § 1.448-2(b)(2)(iii)(B), a taxpayer may make an annual election to use its allocations of income, gain, loss, or deduction from the immediately preceding tax year instead of current year allocations. (Instructions for Form 8990 (Dec. 2025), p. 2)
  • The election is made on a timely filed original return (including extensions).
  • It is only valid for that tax year and once made cannot be revoked.
  • This election applies to ALL Code provisions referencing § 448(a)(3), including Sections 163(j), 263A(i)(1), 460(e)(1)(B), and 471(c)(1).
• Exempt entity pass-through rule. If a partnership or S corporation is an exempt entity (qualifies for the small business exemption), business interest expense allocated to partners or shareholders is NOT subject to § 163(j) at the partner or shareholder level. (Treas. Reg. § 1.163(j)-6(m)(1))
  • A partner or shareholder of an exempt entity includes its share of non-excepted trade or business items when calculating its own ATI.
  • However, if a partner's allocations of non-excepted trade or business losses and deductions exceed its allocations of income and gain from the exempt entity (net loss allocation), such net loss allocation will NOT reduce the partner's ATI.
  • Prior-year excess business interest expense from a partnership that later becomes exempt is treated as business interest expense paid or accrued by the partner in the exempt year. (Treas. Reg. § 1.163(j)-6(m)(3))

TRAP. A partnership that qualifies for the small business exemption is NOT required to file Form 8990, but if any partner is required to file, the partnership must provide information upon request so the partner can complete its return. (Instructions for Form 8990 (Dec. 2025), "Exclusions from filing")

Step 2. The Limitation Formula - § 163(j)(1) Core Computation

"The amount allowed as a deduction under this chapter for any taxable year for business interest shall not exceed the sum of (A) the business interest income of such taxpayer for such taxable year, (B) 30 percent of the adjusted taxable income of such taxpayer for such taxable year, plus (C) the floor plan financing interest of such taxpayer for such taxable year. The amount determined under subparagraph (B) shall not be less than zero." (Section 163(j)(1))

• Formula summary. Deductible Business Interest = BII + (30 percent x ATI) + FPFI. (§ 163(j)(1)(A)-(C))
  • The ATI component (30 percent x ATI) cannot be negative.
  • Floor plan financing interest is fully deductible without regard to the 30 percent ATI cap.
  • Business interest income offsets business interest expense dollar-for-dollar before the 30 percent ATI limitation applies.
• Applicable percentage is 30 percent. The default applicable percentage has been 30 percent since the TCJA. (§ 163(j)(1)(B))
  • The CARES Act temporarily increased the rate to 50 percent for taxable years beginning in 2019 and 2020. That provision has fully expired.
  • The OBBBA did not change the 30 percent rate.
  • For partnerships, the 50 percent rate did NOT apply for 2019. It only applied for 2020.
• Ordering of deductions. Current-year business interest expense is deducted before disallowed business interest expense carryforwards from prior years. Carryforwards are deducted on a first-in-first-out (FIFO) basis. (Treas. Reg. § 1.163(j)-5(b)(2))
• Interaction with other limitations. § 163(j) generally applies AFTER other provisions that limit, disallow, defer, or capitalize interest expense, with the exception of the new interest capitalization ordering rules for tax years beginning after December 31, 2025. (Treas. Reg. § 1.163(j)-3(b)(4))
  • Tentative taxable income is computed after applying Sections 163(f), 267, 704, 1366, 465, 469, 461(l), and 263A.
  • For the interaction with § 267A (hybrid arrangements), see Step 14 below.
  • For the interaction with § 59A (BEAT), see Step 15 below.
• Computation on Form 8990. Part I of Form 8990 performs the computation in four sections.
  • Section I (Lines 1-5) aggregates business interest expense.
  • Section II (Lines 6-22) computes adjusted taxable income.
  • Section III (Lines 23-25) aggregates business interest income.
  • Section IV (Lines 26-31) applies the limitation formula and determines the allowable deduction and any disallowed carryforward.
• Cross-reference to ATI computation. Steps 5 and 6 below detail the additions to and subtractions from tentative taxable income required to compute ATI, which is the critical input for the 30 percent limitation.

Step 3. Business Interest Expense - Definition and Scope

"The term 'business interest' means any interest paid or accrued on indebtedness properly allocable to a trade or business. Such term shall not include investment interest (within the meaning of subsection (d))." (Section 163(j)(5))

• Core definition. Business interest expense means interest expense that is properly allocable to a trade or business, excluding investment interest and, for tax years beginning after December 31, 2025, interest capitalized under Sections 263(g) or 263A(f). (§ 163(j)(5), Treas. Reg. § 1.163(j)-1(b)(7))
  • Interest expense properly allocable to an excepted trade or business is NOT treated as business interest expense. (Treas. Reg. § 1.163(j)-10(a)(2))
  • Post-OBBBA amendment (effective tax years beginning after Dec. 31, 2025). § 163(j)(5) now adds "Such term shall not include any interest which is capitalized under section 263(g) or 263A(f)." (OBBBA § 70341(b))
• Definition of "interest" under the regulations. Treas. Reg. § 1.163(j)-1(b)(22) defines "interest" more broadly than common law, organized into four categories.
  • Category 1 (compensation for use or forbearance of money) includes OID, acquisition discount, deferred interest payments under § 483, swap periodic payments under § 1.446-3(e)(2), and other financing arrangements.
  • Category 2 captures significant nonperiodic swap payments under § 1.446-3(f)(2)(iii).
  • Category 3 includes bond premium deductions under § 171(a)(1), substitute interest payments, § 1258 gain treated as interest, factoring income/expense treated as interest, commitment fees that compensate for use of money, debt issuance costs under § 1.446-5(b)(1), and § 163(j) interest dividends from RICs.
  • Category 4 contains the anti-avoidance rules discussed in Step 16.
• Items excluded from the definition of interest.
  • Guaranteed payments for the use of capital under § 707(c) are explicitly excluded from the definition of interest. (Treas. Reg. § 1.163(j)-1(b)(22)) However, the anti-avoidance rule may still recharacterize such payments as interest.
  • Hedging gains and losses with respect to derivatives that alter effective borrowing cost.
  • Insurance premiums.
• Coordination with other provisions permanently disallowing interest. Business interest expense does NOT include interest expense that is permanently disallowed under another provision of the Code, including Sections 163(e)(5)(A)(i), 163(f), 163(l), 163(m), 264(a), 265, 267A, or 279. (Treas. Reg. § 1.163(j)-3(b)(2))
  • Interest disallowed under § 163(l) (see Step 13) is excluded from § 163(j) analysis entirely.
  • Interest disallowed under § 267A (see Step 14) is excluded from § 163(j) analysis entirely.
• Post-2025 interest capitalization coordination. For tax years beginning after December 31, 2025, the § 163(j) limitation applies BEFORE any interest capitalization provisions (except Sections 263(g) and 263A(f)). (OBBBA § 70341, new § 163(j)(10))
  • The limitation applies to business interest without regard to whether the taxpayer would otherwise deduct or capitalize such interest.
  • Any reference to a deduction for business interest is treated as including a reference to the capitalization of business interest.
  • The amount allowed after the limitation is applied first to capitalized interest, then to deducted interest.
  • No portion of disallowed interest carried forward can later be treated as interest subject to a capitalization provision.
  • This removes a planning strategy where taxpayers elected to capitalize interest to avoid the § 163(j) limitation.

CAUTION. OBBBA redesignated the CARES Act paragraphs. Old § 163(j)(10) (CARES Act 50 percent rule) is now § 163(j)(12). Old § 163(j)(11) is now § 163(j)(13). The new interest capitalization coordination provision is new § 163(j)(10). Ensure correct paragraph references when reading pre- and post-OBBBA authorities.

Step 4. Business Interest Income - Definition and Scope

"The term 'business interest income' means the amount of interest includible in the gross income of the taxpayer for the taxable year which is properly allocable to a trade or business. Such term shall not include investment income (within the meaning of subsection (d))." (Section 163(j)(6))

• Core definition. Business interest income means interest income that is properly allocable to a trade or business, excluding investment income as defined in § 163(d). (§ 163(j)(6), Treas. Reg. § 1.163(j)-1(b)(8))
  • Must be interest includible in gross income.
  • Must be properly allocable to a trade or business.
  • Interest income allocable to an excepted trade or business is NOT treated as business interest income.
• Function in the limitation formula. Business interest income is the first component of the § 163(j)(1) limitation. It offsets business interest expense dollar-for-dollar before the 30 percent ATI limitation applies. (§ 163(j)(1)(A))
  • BII from partnerships and S corporations flows through to partners and shareholders.
  • Excess business interest income (BII exceeding BIE) from pass-through entities increases a partner's or shareholder's own BII for their § 163(j) computation.
• Items treated as interest income. The same broad definition of "interest" in Treas. Reg. § 1.163(j)-1(b)(22) that applies to interest expense also applies to interest income.
  • Includes OID includible in gross income, substitute interest payments received, § 1258 gain, factoring income, and § 163(j) interest dividends from RICs.
• Anti-avoidance for artificial inflation of interest income. Treas. Reg. § 1.163(j)-1(b)(22)(iv)(B) disregards any income realized in a transaction if a principal purpose is to artificially increase the taxpayer's business interest income.
  • The fact that the taxpayer has a business purpose for holding interest-generating assets does not prevent this rule from applying.

Step 5. Adjusted Taxable Income - Additions to Tentative Taxable Income

"The term 'adjusted taxable income' means the taxable income of the taxpayer (A) computed without regard to (i) any item of income, gain, deduction, or loss which is not properly allocable to a trade or business, (ii) any business interest or business interest income, (iii) the amount of any net operating loss deduction under section 172, (iv) the amount of any deduction allowed under section 199A, (v) any deduction allowable for depreciation, amortization, or depletion, and (vi) the amounts included in gross income under sections 951(a), 951A(a), and 78 (and the portion of the deductions allowed under sections 245A(a) (by reason of section 964(e)(4)) and 250(a)(1)(B) by reason of such inclusions)." (Section 163(j)(8)(A), as amended by OBBBA)

• Tentative taxable income as the starting point. ATI begins with "tentative taxable income," defined as taxable income under § 63 computed without regard to the application of § 163(j) and without regard to any disallowed business interest expense carryforwards. (Treas. Reg. § 1.163(j)-1(b)(43))
  • Tentative taxable income is computed AFTER applying Sections 163(f), 267, 704, 1366, 465, 469, 461(l), and 263A (other than the § 163(j) limitation itself).
• Business interest expense. All business interest expense that reduced tentative taxable income is added back, except disallowed business interest expense carryforwards from prior years. (§ 163(j)(8)(A)(ii), Treas. Reg. § 1.163(j)-1(b)(1)(i)(A))
  • Interest expense allocable to excepted trades or businesses is NOT business interest expense and is not added back here. It is instead addressed under Treas. Reg. § 1.163(j)-1(b)(1)(i)(H).
• Net operating loss deduction. Any NOL deduction under § 172 is added back, including NOLs carried forward or carried back. (§ 163(j)(8)(A)(iii), Treas. Reg. § 1.163(j)-1(b)(1)(i)(B))
  • The NOL deduction is determined without regard to § 163(j) itself.
  • The add-back is limited to the amount by which the NOL deduction actually reduced tentative taxable income.
• Qualified business income deduction. Any deduction under § 199A is added back in full. (§ 163(j)(8)(A)(iv), Treas. Reg. § 1.163(j)-1(b)(1)(i)(C))
  • For purposes of determining ATI, the § 199A deduction is determined WITHOUT regard to § 163(j).
  • This means the § 199A deduction is computed as if the § 163(j) limitation does not exist.
• Depreciation, amortization, and depletion. Any deduction allowable for depreciation, amortization, or depletion is added back. (§ 163(j)(8)(A)(v), as restored by OBBBA § 70303(a))
  • This includes depreciation under Sections 167 and 168 (including bonus depreciation under § 168(k)). (Treas. Reg. § 1.163(j)-1(b)(1)(i)(D))
  • This includes amortization of intangibles under Sections 167 and 197, and other amortized expenditures under Sections 174(b), 195(b)(1)(B), 248, and 1245(a)(2)(C). (Treas. Reg. § 1.163(j)-1(b)(1)(i)(E))
  • This includes depletion under § 611. (Treas. Reg. § 1.163(j)-1(b)(1)(i)(F))
  • § 179 expense is treated as amortization for this purpose.
  • Depreciation capitalized to inventory under § 263A is added back in the YEAR OF CAPITALIZATION, regardless of when the capitalized amount is recovered through cost of goods sold. (Treas. Reg. § 1.163(j)-1(b)(1)(iii))
• Capital loss carrybacks and carryovers. Any deduction for a capital loss carryback or carryover is added back. (Treas. Reg. § 1.163(j)-1(b)(1)(i)(G))
  • This is a regulatory addition under § 163(j)(8)(B) authority.
• Losses and deductions not allocable to non-excepted trades or businesses. Any deduction or loss that is not properly allocable to a non-excepted trade or business is added back. (§ 163(j)(8)(A)(i), Treas. Reg. § 1.163(j)-1(b)(1)(i)(H))
  • Includes losses and deductions from excepted trades or businesses (electing real property, electing farming, excepted regulated utilities).
  • Includes personal losses not allocable to any trade or business.
  • For trusts and estates, includes the income distribution deduction under Sections 651 and 661 and the deduction under § 642(c).
• CFC income inclusions (post-2025). For tax years beginning after December 31, 2025, amounts included in gross income under Sections 951(a) (Subpart F), 951A(a) (GILTI), and 78 (gross-up) are added back, along with the portion of deductions allowed under § 245A(a) (by reason of § 964(e)(4)) and § 250(a)(1)(B) by reason of such inclusions. (§ 163(j)(8)(A)(vi), added by OBBBA § 70342(a))
  • This is a statutory exclusion from ATI that supersedes the prior regulatory approach.
  • See Step 11 for the CFC group election implications.

EXAMPLE. Corporation A has taxable income of $1,000,000, business interest expense of $650,000, business interest income of $50,000, depreciation (including bonus) of $450,000, amortization of $50,000, and an NOL deduction of $100,000. For a 2025 calendar year, ATI = $1,000,000 + $650,000 + $100,000 + $450,000 + $50,000 - $50,000 = $2,200,000. The 30 percent limitation = $660,000. Total limitation = $660,000 + $50,000 (BII) = $710,000. Since BIE of $650,000 is less than $710,000, all interest is deductible. Under EBIT (2022-2024), ATI would have been $1,700,000 and $90,000 would have been disallowed.

Step 6. Adjusted Taxable Income - Subtractions from Tentative Taxable Income

"Adjusted taxable income" is computed by taking tentative taxable income, adding back the items in Step 5, and subtracting certain items that would otherwise inflate ATI. (Section 163(j)(8), Treas. Reg. Section 1.163(j)-1(b)(1)(ii))

• Business interest income included in tentative taxable income. Any business interest income that was included in the computation of tentative taxable income is subtracted. (Treas. Reg. § 1.163(j)-1(b)(1)(ii)(A))
  • This prevents double-counting because BII is already added back as a favorable component in the § 163(j)(1) limitation formula.
• Floor plan financing interest expense. Any floor plan financing interest expense included in tentative taxable income is subtracted. (Treas. Reg. § 1.163(j)-1(b)(1)(ii)(B))
  • Floor plan financing interest is fully deductible under § 163(j)(1)(C) and should not reduce ATI.
• Gain recapture on sale of depreciated property. With respect to the sale or other disposition of property, subtract the greater of allowed or allowable depreciation, amortization, or depletion for tax years beginning after December 31, 2017, and before January 1, 2022, with respect to such property. (Treas. Reg. § 1.163(j)-1(b)(1)(ii)(C))
  • This prevents "double counting" of depreciation benefits. If depreciation deductions were added back during the EBITDA period (2018-2021), and the property is later sold at a gain reflecting reduced basis, the gain attributable to depreciation would artificially inflate ATI.
  • Post-OBBBA, this subtraction also applies with respect to depreciation, amortization, or depletion for tax years beginning after December 31, 2024 (the new EBITDA period). (IRS Fact Sheet 2025-9, Topic C, Q4)
  • Taxpayers may use the lesser of gain recognized or the greater of allowed/allowable depreciation, provided this method is applied consistently to ALL dispositions. (Treas. Reg. § 1.163(j)-1(b)(1)(iv)(E))
  • The aggregate subtractions cannot exceed the aggregate depreciation/amortization/depletion deductions with respect to that property. (Treas. Reg. § 1.163(j)-1(b)(1)(iv)(F))
• Consolidated group member stock sale adjustments. On disposition of stock in a consolidated group member, subtract investment adjustments under § 1.1502-32 attributable to depreciation, amortization, or depletion during the EBITDA period. (Treas. Reg. § 1.163(j)-1(b)(1)(ii)(D))
• Partnership interest sale adjustments. On disposition of a partnership interest, subtract the distributive share of partnership depreciation/amortization/depletion under § 704(d). (Treas. Reg. § 1.163(j)-1(b)(1)(ii)(E))
• Income or gain not allocable to non-excepted trades or businesses. Any income or gain that is not properly allocable to a non-excepted trade or business is subtracted. (Treas. Reg. § 1.163(j)-1(b)(1)(ii)(F))
  • Includes gain from sale of personal residence, income from excepted trades or businesses, and investment income (not business interest income).
• Specified deemed inclusions (CFC income) - pre-2026 rule. Under the regulations (pre-dating the OBBBA statutory exclusion), a U.S. shareholder's ATI is reduced by subpart F inclusions, GILTI inclusions (reduced by any § 250(a) deduction), and § 78 gross-up. (Treas. Reg. § 1.163(j)-1(b)(1)(ii)(G))
  • Under the 2020 Proposed Regulations (§ 1.163(j)-7(j)), a U.S. shareholder could include in ATI a portion of specified deemed inclusions attributable to stand-alone applicable CFCs or CFC group members (other than § 78 amounts) equal to the ratio of the CFC's excess taxable income over its ATI.
  • The 2021 Final Regulations reserved on these rules, requiring taxpayers to rely on the 2020 Proposed Regulations.
  • OBBBA § 70342 moots much of this for tax years beginning after December 31, 2025 by statutorily excluding CFC income inclusions. See Step 5 above and Step 11 below.
• ATI cannot be less than zero. Under Treas. Reg. § 1.163(j)-1(b)(1)(vii), ATI is floored at zero. If additions and subtractions yield a negative number, ATI is zero.

Step 7. The EBITDA-to-EBIT Transition and OBBBA Restoration

"The amendments made by this section shall apply to taxable years beginning after December 31, 2024." (OBBBA Section 70303(c), EBITDA Restoration)

• Three distinct ATI periods. The ATI computation has evolved through three distinct phases.
  • Period 1 (2018-2021). EBITDA-based. Depreciation, amortization, and depletion deductions were added back to taxable income.
  • Period 2 (2022-2024). EBIT-based. The phrase "in the case of taxable years beginning before January 1, 2022" in former § 163(j)(8)(A)(v) meant depreciation, amortization, and depletion deductions were NOT added back. This was the strictest period for the limitation.
  • Period 3 (2025 onward). EBITDA restored. OBBBA § 70303(a) struck the temporal limitation, permanently restoring the add-back of depreciation, amortization, and depletion for tax years beginning after December 31, 2024.
• OBBBA restoration of EBITDA. OBBBA § 70303(a) amended § 163(j)(8)(A)(v) by striking "in the case of taxable years beginning before January 1, 2022." The clause now reads simply "any deduction allowable for depreciation, amortization, or depletion." (OBBBA § 70303(a), IRS Fact Sheet 2025-9, Topic E, Q1)
  • This restoration is permanent, unlike the original TCJA sunset.
  • For calendar-year taxpayers, this change is effective for the 2025 tax year.
  • The effect is to increase ATI and thus the 30 percent limitation amount, allowing more interest to be deductible.
• Synergy with 100 percent bonus depreciation. The restoration of EBITDA-based ATI, combined with OBBBA's permanent 100 percent bonus depreciation under § 168(k), creates a powerful synergy.
  • Bonus depreciation generates large depreciation deductions that reduce taxable income.
  • Those same depreciation deductions are added back for ATI purposes.
  • The result is lower taxable income but higher ATI, maximizing the interest deduction limitation.
• CFC exclusion from ATI (effective 2026). OBBBA § 70342(a) added new § 163(j)(8)(A)(vi), which excludes from ATI amounts included in gross income under Sections 951(a), 951A(a), and 78, along with associated deductions. (§ 163(j)(8)(A)(vi), IRS Fact Sheet 2025-9, Topic E, Q2)
  • This applies to tax years beginning after December 31, 2025.
  • U.S. shareholders of CFCs can no longer increase their ATI by including these CFC income amounts.
  • This may reduce the ability of U.S. shareholders with significant CFC operations to deduct interest expense.
• Rev. Proc. 2026-17 transition relief. Rev. Proc. 2026-17, § 6, provides that for the first specified period beginning after December 31, 2024, a designated U.S. person may make or revoke a CFC group election without regard to the 60-month limitation in Treas. Reg. § 1.163(j)-7(e)(5)(ii). (Rev. Proc. 2026-17, § 6, Mar. 18, 2026)
  • This enables taxpayers to reassess their CFC group election position in light of both the EBITDA restoration and the CFC exclusion.

Step 8. Floor Plan Financing Interest

"The term 'floor plan financing interest' means interest paid or accrued on floor plan financing indebtedness." (Section 163(j)(9)(A))

• Definition of floor plan financing indebtedness. Floor plan financing indebtedness means indebtedness (i) used to finance the acquisition of motor vehicles held for sale or lease, and (ii) secured by the inventory so acquired. (§ 163(j)(9)(B))
  • The indebtedness must be used to finance acquisition of motor vehicles held for sale or lease.
  • The indebtedness must be secured by the acquired inventory.
• Definition of motor vehicle. A "motor vehicle" means any self-propelled vehicle designed for transporting persons or property on a public street/highway/road, a boat, or farm machinery or equipment. (§ 163(j)(9)(C)(i)-(iii))
  • Post-OBBBA expansion (effective tax years beginning after Dec. 31, 2024). OBBBA § 70303(b) adds that "motor vehicle" also includes "any trailer or camper which is designed to provide temporary living quarters for recreational, camping, or seasonal use and is designed to be towed by, or affixed to, a motor vehicle." (§ 163(j)(9)(C) flush language, OBBBA § 70303(b))
  • RV dealers, camper dealers, and trailer dealers can now treat their inventory financing interest as FPFI.
• Treatment in the limitation formula. Floor plan financing interest is the third component of the § 163(j)(1) limitation formula and is fully deductible without regard to the 30 percent ATI cap. (§ 163(j)(1)(C))
  • FPFI is subtracted from tentative taxable income when computing ATI. (Treas. Reg. § 1.163(j)-1(b)(1)(ii)(B))
  • There is no ceiling on FPFI.
• Bonus depreciation limitation for FPFI taxpayers. The 30 percent limitation on bonus depreciation under § 168(k)(9)(B) applies to taxpayers who have floor plan financing indebtedness and take FPFI into account under § 163(j).

TRAP. The trailer/camper expansion applies to tax years beginning after December 31, 2024. Dealers with RV, camper, or trailer inventory should review their financing arrangements to determine if they now qualify for the FPFI exception.

Step 9. Excepted Trades or Businesses - Election and Consequences

"The limitation in paragraph (1) shall not apply to an electing real property trade or business, an electing farming business, or an excepted regulated utility trade or business." (Section 163(j)(7)(A))

• Categories of excepted trades or businesses.
  • Employee services (§ 163(j)(7)(A)(i)). The trade or business of performing services as an employee is not treated as a trade or business for § 163(j) purposes. No election is required.
  • Electing real property trade or business (§ 163(j)(7)(A)(ii)). A real property trade or business as defined in § 469(c)(7)(C) that makes an election. Activities include development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, and brokerage.
  • Electing farming business (§ 163(j)(7)(A)(iii)). A farming business as defined in § 263A(e)(4) or Treas. Reg. § 1.263A-4(a)(4) that makes an election.
  • Automatically excepted regulated utility (§ 163(j)(7)(A)(iv)). A trade or business that furnishes or sells electrical energy, water, sewage disposal services, gas or steam through a local distribution system, or transportation of gas or steam by pipeline, with rates established on a cost-of-service and rate-of-return basis. No election required.
  • Electing regulated utility (Treas. Reg. § 1.163(j)-1(b)(15)(iii)). A utility that does not qualify for automatic exception but has rates established by a regulatory body.
• Election procedures. Under Treas. Reg. § 1.163(j)-9(d), an election is made by attaching an election statement to the timely filed original federal income tax return, including extensions.
  • The statement must be titled "§ 1.163(j)-9 Election" and include the taxpayer's name, address, TIN, a description of the electing trade or business with principal business activity code, and a statement that the election is under § 163(j)(7)(B) or (C).
  • For consolidated groups, the agent for the group makes the election.
  • For partnerships, the election is made on the partnership's return and applies only to trades or businesses the partnership conducts. (Treas. Reg. § 1.163(j)-9(d)(4))
  • An election is irrevocable and applies to the taxable year made and all subsequent taxable years. (Treas. Reg. § 1.163(j)-9(c)(1)-(2))
  • An election terminates only if the taxpayer ceases to engage in the electing trade or business (by selling or transferring substantially all assets to an unrelated party), terminates its existence, or ceases operation.
• Rev. Proc. 2021-9 safe harbor for residential living facilities. Rev. Proc. 2021-9 provides a safe harbor allowing a taxpayer managing or operating a "qualified residential living facility" to treat such trade or business as a real property trade or business solely for purposes of making the § 163(j)(7)(B) election.
  • A qualified residential living facility must consist of multiple rental dwelling units serving as primary residences, provide supplemental assistive/nursing/medical services, have at least one licensed healthcare worker on medical staff, derive at least 10 percent of gross rental income from such services, provide services directly (not outsourced), and have independent living units with sleeping/cooking/bathing facilities.
  • Satisfying this safe harbor does NOT mean the taxpayer is a real estate professional under § 469.
  • The safe harbor must be tested annually. Failure in a subsequent year is treated as ceasing the electing trade or business, but reinstatement is automatic if requirements are later met. (Rev. Proc. 2021-9, § 4.04)
• Depreciation consequences of RPTB election. An electing real property trade or business must use the Alternative Depreciation System (ADS) for nonresidential real property (40-year recovery), residential rental property (30-year recovery), and qualified improvement property (20-year recovery). (§ 168(g)(8), Treas. Reg. § 1.163(j)-9(c)(3))
  • Such property is NOT eligible for bonus depreciation under § 168(k).
  • Personal property (5-year, 7-year, and most 15-year property other than QIP) is NOT affected and remains eligible for GDS and bonus depreciation.
• Depreciation consequences of EFB election. An electing farming business must use ADS for any farming property with a recovery period of 10 years or more and cannot claim bonus depreciation. (§ 163(j)(11)(B))
• Rev. Proc. 2026-17 withdrawal of elections. Taxpayers who made RPTB, EFB, or electing regulated utility elections for tax years beginning in 2022, 2023, or 2024 may withdraw those elections. (Rev. Proc. 2026-17, § 3.01, Mar. 18, 2026)
  • The deadline is the earlier of October 15, 2026 or the end of the applicable period of limitations on assessment.
  • The withdrawal is made by filing an amended return with a statement titled "Revenue Procedure 2026-17 § 163(j)(7) Election Withdrawal."
  • Taxpayers may also make a late § 168(k)(7) election not to deduct bonus depreciation.
  • For BBA partnerships, amended Forms 1065 may be filed instead of AARs (temporary relief).
  • The taxpayer will be treated as if the election had never been made. (Rev. Proc. 2026-17, § 4.02)

TRAP. The decision to withdraw an RPTB election requires modeling both the interest limitation under the restored EBITDA-based ATI and the value of claiming bonus depreciation on QIP and real property. The October 15, 2026 deadline is firm.

Step 10. Partnership Application of § 163(j)

"In the case of any partnership (i) this subsection shall be applied at the partnership level and any deduction for business interest shall be taken into account in determining the non-separately stated taxable income or loss of the partnership, and (ii) the adjusted taxable income of each partner of such partnership shall be determined without regard to such partner's distributive share of any items of income, gain, deduction, or loss of such partnership, and shall be increased by such partner's distributive share of such partnership's excess taxable income." (Section 163(j)(4)(A))

• Entity-level application. § 163(j) applies at the partnership level, not the partner level. Any deduction for business interest expense is taken into account in determining the non-separately stated taxable income or loss of the partnership. (§ 163(j)(4)(A)(i), Treas. Reg. § 1.163(j)-6(a))
  • Deductible business interest expense flows through as part of the partnership's nonseparately stated income/loss and is not re-tested at the partner level. (Treas. Reg. § 1.163(j)-6(c)(4))
  • However, deductible BIE and excess business interest expense retain their character as business interest expense at the partner level for other purposes (e.g., § 469 passive activity rules).
• Partner ATI exclusion and add-back. A partner's ATI is determined WITHOUT regard to any partnership items of income, gain, deduction, or loss. (§ 163(j)(4)(A)(ii)(I))
  • Partner ATI is INCREASED by the partner's distributive share of the partnership's excess taxable income (ETI). (§ 163(j)(4)(A)(ii)(II))
  • A partner does NOT include business interest income from a partnership except to the extent allocated excess business interest income (EBII). (Treas. Reg. § 1.163(j)-6(l)(1)(iii))
• Excess business interest expense (EBIE). The amount of business interest not allowed to the partnership is NOT treated as business interest paid or accrued by the partnership in the succeeding year. Instead, it is allocated to each partner in the same manner as the non-separately stated taxable income or loss. (§ 163(j)(4)(B)(i))
  • EBIE is allocated to partners immediately and carried forward at the PARTNER level, not the partnership level.
  • Partner basis is reduced (but not below zero) by the amount of EBIE allocated. (Treas. Reg. § 1.163(j)-6(h)(2))
  • EBIE is treated as business interest paid or accrued by the partner in a succeeding year when the partner is allocated ETI or EBII from the same partnership, but only to the extent of such ETI or EBII. (§ 163(j)(4)(B)(ii), Treas. Reg. § 1.163(j)-6(g)(2))
  • Partners with EBIE from multiple years use a FIFO approach.
• Excess taxable income (ETI). ETI is the amount of a partnership's ATI that exceeds the amount of ATI required to support the partnership's business interest expense deduction. (Treas. Reg. § 1.163(j)-1(b)(18))
  • ETI is allocated to partners in the same manner as nonseparately stated taxable income or loss.
  • An allocation of ETI increases the partner's ATI for purposes of the partner's own § 163(j) limitation.
• Excess business interest income (EBII). EBII is the amount by which a partnership's business interest income exceeds its business interest expense. (Treas. Reg. § 1.163(j)-6(b)(4))
  • EBII allocated to a partner increases the partner's business interest income for the partner's own § 163(j) limitation.
• The 11-step allocation computation. Treas. Reg. § 1.163(j)-6(f)(2) prescribes an 11-step computation for allocating deductible BIE and § 163(j) excess items among partners.
  • Step 1 determines the partnership-level § 163(j) limitation.
  • Step 2 determines each partner's allocable ATI, BII, and BIE.
  • Steps 3 through 10 perform matching, priority, and allocation computations.
  • Step 11 produces the final allocation of deductible BIE, EBIE, ETI, and EBII to each partner.
  • If a partnership allocates all § 163(j) items proportionately in Step 2, Steps 3 through 10 are unnecessary. (Form 8990 Instructions)
• § 704(d) basis limitation interaction. Treas. Reg. § 1.163(j)-6(h) creates a separate § 704(d) loss class for business interest expense items.
  • Within this class, deductible business interest expense is taken into account before any EBIE or "negative § 163(j) expense." (IRS Q&A Topic C, Q10)
  • "Negative § 163(j) expense" refers to EBIE from a prior year that was suspended under § 704(d) due to lack of partner basis.
  • When a partner has sufficient basis in a later year, negative § 163(j) expense becomes EBIE and reduces basis at that time.
• Basis increase on disposition of partnership interest. Under Treas. Reg. § 1.163(j)-6(h)(3), if a partner disposes of an interest, the basis is increased immediately before disposition by (total basis reductions for EBIE minus EBIE previously treated as BIE paid or accrued) multiplied by the ratio of FMV of transferred interest to total FMV of partnership interest.
  • For a complete disposition (including complete liquidation), the ratio is 1.0, so the full unused basis reduction is added back.
  • For a partial disposition, the add-back is proportionate to the fraction of interest transferred.
  • No deduction under § 163(j) is allowed to the transferor or transferee for any EBIE or negative § 163(j) expense upon disposition. The partner gets a basis increase instead.
• Self-charged lending transactions (partner-to-partnership loans). Treas. Reg. § 1.163(j)-6(n) addresses when a partner lends to a partnership.
  • If a lending partner is allocated EBIE and has interest income from the self-charged loan, the partner is deemed to receive an allocation of EBII from the partnership equal to the lesser of the EBIE allocation or the interest income from the loan.
  • This prevents double disallowance where partnership BIE is limited under § 163(j) and the partner's interest income is subject to § 163(d).
  • This rule does NOT apply to loans from a partnership to a partner, loans by indirect partners, or loans by S corporation shareholders.
• Trading partnerships - bifurcation rules. A trading partnership must bifurcate its interest expense between partners that materially participate and partners that do not. (Treas. Reg. § 1.163(j)-6(c)(2))
  • Only the portion allocable to materially participating partners is subject to § 163(j) at the partnership level.
  • Items from trading activities allocable to non-materially-participating partners are treated as investment activity items subject to § 163(d), not § 163(j).
  • Corporate partners in trading partnerships are never subject to § 163(d), so the bifurcation rule does not apply to them.
• § 743(b) and § 704(c) adjustments. § 743(b) adjustments are excluded from the partnership's ATI computation but are included in the partner's ATI computation. (Treas. Reg. § 1.163(j)-6(b)(2), (d)(3), (e)(2))
  • § 704(c) remedial allocations are also excluded from the partnership's § 163(j) computation and from the 11-step allocation.

Step 11. S Corporations and Consolidated Groups

"For purposes of applying subsection (a) to members of a consolidated group, the taxable income of the consolidated group shall be the taxable income of the consolidated group as determined for purposes of the consolidated return regulations." (Treas. Reg. Section 1.163(j)-4(d)(2)(i))

• S corporations - entity-level application. The § 163(j) limitation is applied at the S corporation level. (Treas. Reg. § 1.163(j)-6(l)(1)(i))
  • Unlike partnerships, S corporations carry forward disallowed business interest expense at the ENTITY level, not at the shareholder level.
  • Current-year BIE is deducted before carryforwards. Carryforwards are deducted FIFO.
  • Excess taxable income and excess business interest income are allocated to shareholders pro rata under § 1366(a)(1).
  • An S corporation shareholder's stock basis is reduced (but not below zero) when a disallowed BIE carryforward becomes deductible.
  • The AAA is adjusted to take into account business interest expense in the year the S corporation treats it as deductible.
  • If a QSub election terminates, any disallowed BIE carryforward attributable to the QSub remains with the parent S corporation. (Treas. Reg. § 1.163(j)-6(l)(8))
• Consolidated groups - single limitation. A consolidated group has a single § 163(j) limitation computed at the consolidated return level. (Treas. Reg. § 1.163(j)-4(d)(2)(i))
  • The group files one Form 8990.
  • The group's ATI is computed using consolidated taxable income under Treas. Reg. § 1.1502-11, without regard to any carryforwards or disallowances under § 163(j).
  • Intercompany obligations are fully disregarded. Interest expense and interest income from intercompany obligations are not treated as business interest expense or business interest income. (Treas. Reg. § 1.163(j)-4(d)(2)(v)(A))
• Allocation of limitation among group members. Treas. Reg. § 1.163(j)-5(b)(3)(ii)(C) provides a three-step allocation.
  • If the group's limitation equals or exceeds aggregate current-year BIE, no disallowance.
  • If aggregate current-year BIE exceeds the limitation, each member first deducts BIE up to its own BII plus floor plan financing interest.
  • Any remaining limitation is allocated proportionately among members with remaining current-year BIE.
• SRLY rules for carryforwards. Treas. Reg. § 1.163(j)-5(d) applies a cumulative SRLY limitation to disallowed BIE carryforwards arising in a separate return limitation year.
  • The final regulations adopted a cumulative SRLY register (not annual). Unused SRLY limitation carries forward.
  • SRLY carryforwards are only available after current-year BIE and non-SRLY carryforwards are deducted.
  • The SRLY rules do not apply if there is a contemporaneous § 382 ownership change (overlap rule).
• Member departing consolidated group. A departing member's current-year BIE and carryforwards are first made available to the consolidated group in the year of departure. (Treas. Reg. § 1.163(j)-5(b)(3)(ii)(C)(5))
  • Only the amount not deducted by the group may be carried to the departing member's first separate return year.
  • Disallowed BIE carryforwards are Category C attributes under the unified loss rule and can be reattributed by election. EBIE from a partnership is a Category D attribute and cannot be reattributed. (Treas. Reg. § 1.163(j)-4(f)(4))
• CFCs - standalone application. § 163(j) applies to any foreign corporation that is a CFC with at least one U.S. shareholder owning stock within the meaning of § 958(a). (Treas. Reg. § 1.163(j)-7(b))
  • The limitation applies for purposes of computing subpart F income, tested income (GILTI), and ECI.
  • The disallowance and carryforward of a foreign corporation's BIE does not affect whether and when such BIE reduces earnings and profits. (Treas. Reg. § 1.163(j)-7(e))
• CFC group election. Related CFCs can elect to compute a single § 163(j) limitation on a group basis, analogous to the consolidated group approach. (Treas. Reg. § 1.163(j)-7(c)(2))
  • A specified group parent must own (directly or indirectly) 80 percent of stock by value in one or more applicable CFCs.
  • The election is made by each designated U.S. person and cannot be revoked for 60 months.
  • Rev. Proc. 2026-17 allows revocation or making a CFC group election without regard to the 60-month limitation for the first specified period beginning after December 31, 2024. (Rev. Proc. 2026-17, § 6)
  • ECI deemed corporations are treated as separate from the CFC group.
  • Post-OBBBA, the principal benefit of the CFC group election (gaining access to CFC-level excess § 163(j) limitation to increase U.S. shareholder ATI) has been removed because CFC income inclusions are now statutorily excluded from ATI.

Step 12. Disallowed Business Interest Carryforward

"The amount of any business interest not allowed as a deduction for any taxable year by reason of paragraph (1) shall be treated as business interest paid or accrued in the succeeding taxable year." (Section 163(j)(2))

• Indefinite carryforward for C corporations. Disallowed business interest expense is carried forward indefinitely. There is no expiration date. (§ 163(j)(2), Treas. Reg. § 1.163(j)-2(c)(1))
  • The carried-forward amount is treated as "business interest paid or accrued" in the succeeding year and is subject to the § 163(j)(1) limitation again in that year.
  • Carryforwards are not reallocated between non-excepted and excepted trades or businesses. They continue to be treated as allocable to a non-excepted trade or business.
• Small business exemption coordination. If a taxpayer qualifies for the small business exemption in a carryforward year, the disallowed business interest expense carryforward is NOT subject to limitation in that year and can be fully deducted. (Treas. Reg. § 1.163(j)-2(c))
• Partnership special rule. Partnership EBIE is NOT treated as business interest paid or accrued by the partnership in the succeeding year. Instead, it is allocated to partners as excess business interest expense. (§ 163(j)(4)(B)(i)(I))
  • Partners carry EBIE forward at the partner level. See Step 10.
• S corporation rule. S corporations carry forward disallowed business interest expense at the entity level (similar to C corporations), not at the shareholder level. (Treas. Reg. § 1.163(j)-6(l)(1)(i))
• Consolidated group carryforwards. Pre-group disallowed BIE carryforwards are subject to a cumulative SRLY limitation. See Step 11.
• Pre-2018 carryforwards. Disallowed business interest expense carryforwards from taxable years beginning before January 1, 2018 (under the old § 163(j) earnings stripping rules) are NOT treated as base erosion payments for BEAT purposes. (Treas. Reg. § 1.59A-3(b)(3)(ix))

Step 13. § 163(l) - Disqualified Debt Instruments

"No deduction shall be allowed under this chapter for any interest paid or accrued on a disqualified debt instrument." (Section 163(l)(1))

• Scope and effect. § 163(l) applies only to debt instruments issued by corporations. The disallowance is absolute - no deduction is allowed for any interest (paid, accrued, or paid in property) on a disqualified debt instrument. (§ 163(l)(1))
  • The provision does not affect the characterization of an instrument as debt or equity, nor does it affect the treatment of the holder.
  • Generally applicable to disqualified debt instruments issued after June 8, 1997.
• Definition of disqualified debt instrument. A disqualified debt instrument is any indebtedness of a corporation that is "payable in equity" of the issuer, a related party, or equity held by the issuer (or any related party) in any other person. (§ 163(l)(2))
• When indebtedness is treated as payable in equity - § 163(l)(3). Three tests determine when indebtedness is "payable in equity."
  • Subparagraph (A). A substantial amount of principal or interest is required to be paid or converted, or at the option of the issuer or a related party is payable in or convertible into, equity.
  • Subparagraph (B). A substantial amount of principal or interest is required to be determined, or at the option of the issuer or a related party is determined, by reference to the value of equity.
  • Subparagraph (C). The indebtedness is part of an arrangement reasonably expected to result in a transaction described in (A) or (B).
• Flush language - holder option with substantial certainty. Principal or interest is treated as required to be paid/converted/determined if it may be required at the option of the holder or a related party to the holder and there is a "substantial certainty the option will be exercised." (§ 163(l)(3) flush language)
  • This applies to holder options, not issuer options. If the issuer or a related party has the option, the "substantial certainty" test does NOT apply - the mere existence of the option is sufficient.
  • PLR 201517003 (Apr. 24, 2015) concluded that for convertible debt where the holder (related to the issuer) has the conversion option, the instrument is a disqualified debt instrument only if there is substantial certainty the option will be exercised. The IRS found a "Congressional preference for treating convertible debt instruments as valid debt in most cases."
  • The legislative history provides a safe harbor. "It is not expected that the provision will affect debt with a conversion feature where the conversion price is significantly higher than the market price of the stock on the issue date of the debt." (H.R. Rep. No. 105-220, at 524 (1997))
• Related party definition. A person is a related party if such person bears a relationship described in § 267(b) or § 707(b). (§ 163(l)(6))
  • § 267(b) relationships include family members, greater-than-50-percent-owned corporations, related trusts, and related estates.
  • § 707(b) relationships include a partnership and a greater-than-50-percent owner, and two partnerships with common greater-than-50-percent owners.
  • Constructive ownership rules of § 267(c) apply.
• Basis increase for third-party equity. If a disqualified debt instrument is payable in equity held by the issuer (or a related party) in any other person that is NOT a related party, the basis of such equity is increased by the amount of disallowed interest. (§ 163(l)(4))
  • No basis increase is available when the debt is payable in equity of the issuer itself or a related party. In those more common cases, the disallowance is a pure deadweight loss.
• Securities dealer exception. The term disqualified debt instrument does not include indebtedness issued by a dealer in securities (or a related party) payable in or by reference to equity (other than equity of the issuer or a related party) held in its capacity as a dealer. (§ 163(l)(5))
• Coordination with § 249. § 249 disallows a deduction for any premium paid on repurchase of convertible debt to the extent the repurchase price exceeds the adjusted issue price plus a normal call premium on non-convertible debt. (§ 249(a))
  • § 249 and § 163(l) operate independently. § 163(l) disallows interest accruals on disqualified debt. § 249 disallows repurchase premiums on convertible debt.
  • A conversion into stock is treated as a "repurchase" for § 249 purposes.
• No regulations issued. Despite being enacted in 1997, no Treasury regulations have been issued under § 163(l). PLR 201517003 is the most important interpretive guidance, though it may not be used or cited as precedent under § 6110(k)(3).

TRAP. When the holder of convertible debt is related to the issuer, literal application of § 163(l)(3)(A) could automatically disqualify the debt because the holder is a "related party." PLR 201517003 resolved this by requiring "substantial certainty" analysis for related-party holder options, but because no regulations have been issued, practitioners should analyze instruments conservatively.

Step 14. § 267A - Disallowance for Hybrid and Branch Arrangements

"No deduction shall be allowed under this chapter for any disqualified related party amount paid or accrued pursuant to a hybrid transaction or by, or to, a hybrid entity." (Section 267A(a))

• Three exclusive circumstances for disallowance. Treas. Reg. § 1.267A-1(b) sets forth the exclusive circumstances in which a deduction is disallowed under § 267A.
  • A disqualified hybrid amount under § 1.267A-2.
  • A disqualified imported mismatch amount under § 1.267A-4.
  • A specified payment satisfying the anti-avoidance rule of § 1.267A-5(b)(6).
• Disqualified related party amount. This means any interest or royalty paid or accrued to a related party to the extent (A) such amount is not included in the related party's income under the tax law of the country of which it is a resident, or (B) the related party is allowed a deduction with respect to such amount under such country's tax law. (§ 267A(b)(1))
  • Excludes any payment to the extent included in the gross income of a U.S. shareholder under § 951(a) (Subpart F).
  • "Related party" means a related person as defined in § 954(d)(3), applied with respect to the person making the payment. (§ 267A(b)(2))
• Hybrid transaction. A hybrid transaction means any transaction, series of transactions, agreement, or instrument where one or more payments are treated as interest or royalties for U.S. tax purposes but are NOT so treated for purposes of the recipient country's tax law. (§ 267A(c))
  • A payment is deemed made pursuant to a hybrid transaction if the taxable year in which the recipient takes the payment into account under its tax law ends more than 36 months after the U.S. taxable year in which the deduction would be allowed. (Treas. Reg. § 1.267A-2(a)(2)(ii)(A))
  • Payments imputed as interest under § 482 or 7872 but not recognized under foreign tax law are deemed hybrid transactions. (Treas. Reg. § 1.267A-2(a)(4))
• Hybrid entity. A hybrid entity is any entity that is (1) treated as fiscally transparent for U.S. purposes but not for foreign purposes, or (2) treated as fiscally transparent for foreign purposes but not for U.S. purposes. (§ 267A(d))
• Specific hybrid arrangements under Treas. Reg. § 1.267A-2.
  • Disregarded payments. The excess of a specified party's disregarded payments over its dual inclusion income is a disqualified hybrid amount. (Treas. Reg. § 1.267A-2(b)(1))
  • Deemed branch payments. If a specified payment is a deemed branch payment and the home office provides an exclusion for income attributable to the branch, the payment is a disqualified hybrid amount. (Treas. Reg. § 1.267A-2(c))
  • Reverse hybrid payments. If a payment to a reverse hybrid (fiscally transparent in its country of organization but not in the investor's country) results in a no-inclusion by an investor, the payment is a disqualified hybrid amount. (Treas. Reg. § 1.267A-2(d))
  • Branch mismatch payments. If income is attributed to a branch by the home office but not taxed in the branch jurisdiction, the payment is a disqualified hybrid amount. (Treas. Reg. § 1.267A-2(e))
  • All hybrid arrangements require relatedness or participation in a structured arrangement. (Treas. Reg. § 1.267A-2(f))
• Imported mismatch rule (Treas. Reg. § 1.267A-4). An imported mismatch payment is disqualified to the extent the income attributable to it is offset by a hybrid deduction incurred by a related foreign tax resident.
  • A "hybrid deduction" includes (i) a deduction allowed under foreign tax law for an amount that is interest or royalty under such law, to the extent the deduction would be disallowed if the foreign law contained rules similar to § 267A, and (ii) deductions with respect to equity, such as notional interest deductions.
  • Notional interest deductions are hybrid deductions only if allowed for an accounting period beginning on or after December 20, 2018.
  • The set-off rules follow a three-tier ordering. First, hybrid deductions offset income from factually-related imported mismatch payments. Second, income from payments that directly fund the hybrid deduction. Third, income from payments that indirectly fund the hybrid deduction.
• De minimis exception. Treas. Reg. § 1.267A-1(c) provides that the disallowance rules do not apply if the sum of the specified party's specified payments that would otherwise be disallowed is less than $50,000.
  • Related specified parties are treated as a single specified party for this purpose.
• Anti-avoidance rule (Treas. Reg. § 1.267A-5(b)(6)). A deduction is disallowed if (i) the payment is not included in the income of a tax resident or taxable branch, and (ii) a principal purpose of the terms or structure of the arrangement is to avoid § 267A.
  • This rule does not apply to disregard a restructuring of a hybrid arrangement into a non-hybrid arrangement.
• Coordination with § 163(j). § 267A applies BEFORE § 163(j). (Treas. Reg. § 1.267A-5(b)(1)(ii))
  • Interest expense permanently disallowed under § 267A is excluded entirely from § 163(j) calculations. It is not business interest expense for § 163(j) purposes.
  • § 267A also applies before Sections 461(l), 465, and 469.
• Effect on earnings and profits. The disallowance of a deduction under § 267A generally does not affect whether the amount reduces earnings and profits. However, a CFC's earnings and profits are NOT reduced by a specified payment if a principal purpose of the transaction was to reduce or limit the CFC's subpart F income. (Treas. Reg. § 1.267A-5(b)(4))
• Applicability date. The regulations apply to taxable years ending on or after December 20, 2018, provided such taxable years begin after December 31, 2017. (Treas. Reg. § 1.267A-7(a))
  • Taxpayers may apply the regulations in their entirety for taxable years beginning after December 31, 2017, and ending before December 20, 2018.

Step 15. § 59A BEAT - Coordination with Interest Limitations

"There is hereby imposed on each applicable taxpayer for any taxable year a tax equal to the base erosion minimum tax amount for the taxable year." (Section 59A(a))

• Applicable taxpayer requirements. An applicable taxpayer must satisfy all three tests. (§ 59A(e)(1))
  • The taxpayer must be a corporation other than a RIC, REIT, or S corporation.
  • Average annual gross receipts for the 3-taxable-year period must be at least $500,000,000.
  • The base erosion percentage must be 3 percent or higher (2 percent for bank/securities dealer affiliated groups).
• BEAT rate structure.
  • 2018 calendar year. 5 percent.
  • 2019 through 2025. 10 percent.
  • Post-2025 (OBBBA). 10.5 percent. (OBBBA § 70331)
  • Bank/securities dealer add-on. Plus 1 percentage point (11.5 percent post-OBBBA).
  • OBBBA eliminated the scheduled increase to 12.5 percent and made the pre-2026 credit treatment permanent. Research credit is fully excluded from the credit reduction. Applicable § 38 credits receive 80 percent treatment.
• § 59A(c)(3) allocation rule - critical coordination. When § 163(j) limits a taxpayer's interest deduction, the disallowed amount is deemed allocated FIRST to unrelated-party interest and SECOND to related-party interest. (§ 59A(c)(3), Treas. Reg. § 1.59A-3(c)(4)(ii)(B))
  • This ensures that the allowed deduction is treated first as related-party interest (maximizing base erosion tax benefits).
  • Example from Treas. Reg. § 1.59A-3(c)(4)(ii)(B). DC has ATI of $1,000x, pays $420x to unrelated Bank, and $360x to foreign parent FP. § 163(j) allows only $300x. Under the ordering rule, the entire $300x allowed is treated as interest paid to FP (foreign related party). All $300x is a base erosion tax benefit. The $480x disallowed carryforward is treated first as unrelated ($420x to Bank), then as related ($60x to FP).
• Interest payments as base erosion payments. Interest expense paid or accrued to a foreign related party is a quintessential base erosion payment under § 59A(d)(1), unless an exception applies.
  • The ECI exception applies if the interest income is subject to U.S. net basis tax as effectively connected income.
  • The withholding tax exception applies if tax is imposed under § 871 or 881 and properly withheld.
• Pre-2018 carryforwards. Disallowed business interest expense carryforwards from pre-2018 years under the old § 163(j) are NOT treated as base erosion payments. However, interest disallowed under current § 163(j) that is carried forward IS treated as a base erosion payment in the year the interest was originally paid or accrued. (Treas. Reg. § 1.59A-3(b)(3)(ix))
• BEAT waiver election. Under Treas. Reg. § 1.59A-3(c)(6), a taxpayer may elect to waive deductions that would otherwise be base erosion tax benefits.
  • The taxpayer must determine it would be an applicable taxpayer but for the waiver.
  • The election is made on an original return, can be increased on amended returns, but cannot be decreased or revoked.
  • Waived deductions are treated as waived for ALL purposes under the Code, EXCEPT that the waiver is disregarded for purposes of whether a deduction is allowed under § 267A.
  • Partnerships cannot make this election. Only corporate partners can.
• OBBBA changes affecting the BEAT-§ 163(j) interaction.
  • EBITDA restoration (2025+). Increases the § 163(j) limitation, potentially allowing more interest deductions, which through the § 59A(c)(3) allocation may increase base erosion tax benefits.
  • CFC exclusion from ATI (2026+). Reduces ATI for taxpayers with CFC inclusions, potentially increasing § 163(j) disallowance, which through § 59A(c)(3) may decrease base erosion tax benefits.

Step 16. Anti-Avoidance Rules and Economic Substance Doctrines

"Any expense or loss economically equivalent to interest is treated as interest expense if a principal purpose of structuring the transaction(s) is to reduce an amount incurred by the taxpayer that otherwise would have been described in paragraph (b)(22)(i), (ii), or (iii) of this section." (Treas. Reg. § 1.163(j)-1(b)(22)(iv)(A)(1))

• Treas. Reg. § 1.163(j)-1(b)(22)(iv) - interest definition anti-avoidance. Any expense or loss economically equivalent to interest is treated as interest expense if a principal purpose of structuring the transaction(s) is to reduce interest expense. (Treas. Reg. § 1.163(j)-1(b)(22)(iv)(A)(1))
  • The four-part test requires the expense to be (i) deductible, (ii) incurred in a transaction securing the use of funds for a period of time, (iii) substantially incurred in consideration of the time value of money, and (iv) not already described in Categories 1-3 of the interest definition.
  • The fact that the taxpayer has a business purpose for obtaining funds does not prevent this rule from applying.
  • The fact that the taxpayer obtained funds at a lower pre-tax cost does not prevent this rule from applying.
  • A corresponding rule treats income as interest income if the payor treats a matching expense as interest and the income is substantially earned in consideration of the time value of money provided. (Treas. Reg. § 1.163(j)-1(b)(22)(iv)(A)(2))
  • A two-way rule in (b)(22)(iv)(B) also disregards income if a principal purpose is to artificially increase business interest income.
• Treas. Reg. § 1.163(j)-2(j) - general anti-avoidance. Arrangements entered into with a principal purpose of avoiding the rules of § 163(j), including the use of multiple entities to avoid the gross receipts test, may be disregarded or recharacterized by the Commissioner. (Treas. Reg. § 1.163(j)-2(j))
  • The (b)(22)(iv) rules take precedence for determining whether an item IS interest expense or interest income.
• Treas. Reg. § 1.163(j)-10(c)(8) - asset allocation anti-abuse. If a principal purpose for the acquisition, disposition, or change in use of an asset was to artificially shift basis between excepted and non-excepted trades or businesses on a determination date, the change is disregarded. (Treas. Reg. § 1.163(j)-10(c)(8))
  • A purpose is irrebuttably presumed if the transaction lacks a substantial business purpose and increases basis in excepted trade or business assets by more than 10 percent during the taxable year.
• Treas. Reg. § 1.59A-9 - BEAT anti-abuse rules.
  • Intermediary transaction anti-abuse (§ 1.59A-9(b)(1)). If a taxpayer pays an intermediary and a principal purpose is avoiding a base erosion payment, the intermediary is disregarded.
  • Denominator manipulation anti-abuse (§ 1.59A-9(b)(2)). Transactions with a principal purpose of increasing the denominator of the base erosion percentage are disregarded.
  • Bank/securities dealer avoidance (§ 1.59A-9(b)(3)). Transactions with a principal purpose of avoiding bank/securities dealer rules are not taken into account.
  • Basis step-up anti-abuse (§ 1.59A-9(b)(4)). If a transaction increases basis of property acquired in a specified nonrecognition transaction and a principal purpose was to increase depreciation without increasing BETBs, the SNT exception does not apply to the extent of the basis increase. An irrebuttable presumption applies if the step-up transaction is between related parties, within six months of the acquisition, and increases depreciable basis.
• Economic substance doctrine (§ 7701(o)). Transactions lacking economic substance may be disregarded for tax purposes. The doctrine requires that a transaction (i) changes the taxpayer's economic position in a meaningful way (apart from federal income tax effects), and (ii) the taxpayer has a substantial purpose for entering into the transaction (apart from federal income tax effects).
  • If a transaction lacks economic substance, the accuracy-related penalty under § 6662(b)(6) is 40 percent of the underpayment (rather than the standard 20 percent).
  • In the context of interest limitations, courts have applied the economic substance doctrine and the step-transaction doctrine to recharacterize financing arrangements designed to generate interest deductions without meaningful economic substance.

Step 17. Documentation, Reporting (Form 8990), and Elections

"Each taxpayer that is making an allocation under this paragraph (c) must prepare a statement titled 'Section 163(j) Asset Basis Calculations' containing the information described in paragraphs (c)(6)(iii)(B)(1) through (7) of this section and must attach the statement to its timely filed Federal income tax return for the taxable year." (Treas. Reg. Section 1.163(j)-10(c)(6)(iii)(B))

• Form 8990 filing requirements. A taxpayer must file Form 8990 if its business interest expense deduction is limited under § 163(j)(1) or if it is allocated EBIE, ETI, or EBII from a pass-through entity. (Instructions for Form 8990 (Rev. Jan. 2025))
  • A small business taxpayer that meets the gross receipts test is generally NOT required to file Form 8990.
  • A corporation must file Form 8990 if it has average annual gross receipts of $500 million or more (for BEAT purposes) even if § 163(j) does not ultimately apply.
• Form 8990 structure.
  • Part I (Lines 1-31). Computation of allowable business interest expense, including BIE aggregation, ATI computation, BII aggregation, and the limitation calculation.
  • Part II (Line 32-37). Partnership pass-through items (EBIE, ETI, EBII).
  • Part III (Lines 38-42). S corporation pass-through items (ETI, EBII).
  • Schedule A. Partner's summary of § 163(j) excess items from partnerships.
  • Schedule B. S corporation shareholder's summary of excess items.
• Partnership worksheets. Worksheet A performs the 11-step allocation of deductible BIE and § 163(j) excess items among partners per Treas. Reg. § 1.163(j)-6(f)(2). Worksheet B is used when priority right to ATI capacity excess conditions are met. (Instructions for Form 8990)
  • Partnerships that allocate all § 163(j) items in Step 2 proportionately do not need to use Worksheets A and B.
• Election statements under Treas. Reg. § 1.163(j)-9.
  • The election statement for RPTB or EFB elections must be titled "§ 1.163(j)-9 Election" and include the taxpayer's name, address, TIN, description of the electing trade or business with principal business activity code, and a statement identifying the election as under § 163(j)(7)(B) or (C). (Treas. Reg. § 1.163(j)-9(d)(2))
  • For electing regulated utility trades or businesses, the statement must be titled "§ 1.163(j)-1(b)(15)(iii) Election."
  • Multiple trades or businesses may be elected on a single statement.
• Asset allocation statement under Treas. Reg. § 1.163(j)-10(c)(6)(iii).
  • Each taxpayer making an allocation must prepare a statement titled "§ 163(j) Asset Basis Calculations" containing seven required components and attach it to the timely filed federal income tax return. (Treas. Reg. § 1.163(j)-10(c)(6)(iii)(B))
  • The seven components are (1) adjusted basis in assets, (2) determination dates, (3) entity information, (4) look-through basis information, (5) methodology summary, (6) approach election, and (7) methodology change description.
  • Failure to file this statement or filing a non-compliant statement may result in the Commissioner treating ALL interest expense as properly allocable to a non-excepted trade or business. (Treas. Reg. § 1.163(j)-10(c)(6)(iv))
  • This penalty may be avoided by showing reasonable cause and good faith.
• Recordkeeping requirements. Taxpayers must maintain books of account and records sufficient to substantiate the § 163(j) limitation computation, asset basis allocations, partnership allocation computations, and carryforward tracking. (Treas. Reg. § 1.163(j)-10(c)(6)(iii)(A), § 1.6001-1)
• Rev. Proc. 2020-22 - CARES Act elections. This revenue procedure provided procedures for making elections under the CARES Act, including election out of the 50 percent ATI limitation, election to substitute 2019 ATI for 2020 ATI, and election out of the 50 percent EBIE rule for partners. (Rev. Proc. 2020-22, 2020-18 I.R.B. 745)
  • The election out of the 50 percent ATI limitation was made by filing a return using the 30 percent limitation. No formal statement was required.
  • These provisions are relevant only for amended return filings, as the CARES Act provisions have fully expired.
• Rev. Proc. 2021-9 - REIT safe harbor. See Step 9 for the residential living facility safe harbor. This revenue procedure requires record retention under § 6001 to substantiate all safe harbor requirements. (Rev. Proc. 2021-9, § 4.03)
• Rev. Proc. 2026-17 - withdrawal of elections. See Step 9 for procedures to withdraw RPTB, EFB, and electing regulated utility elections for tax years beginning in 2022, 2023, or 2024. The critical deadline is the earlier of October 15, 2026 or the end of the applicable period of limitations on assessment. (Rev. Proc. 2026-17, Mar. 18, 2026)
• Penalties. Failure to file Form 8990 may trigger penalties under § 6651 (5 percent per month, up to 25 percent). An improper § 163(j) computation resulting in excessive deductions could trigger the § 6662 accuracy-related penalty (20 percent) if attributable to negligence. (Sections 6651(a)(1), 6662(b)(1))

Step 18. State Tax Conformity and Decoupling

"Taxpayers benefiting from these federal provisions must maintain separate Virginia records and calculate depreciation, amortization, carryforwards, and adjustments as if [OBBBA] changes had not been enacted." (Virginia Tax Bulletin 26-1, Feb. 20, 2026)

• Three types of state IRC conformity.
  • Rolling conformity. The state automatically adopts current IRC provisions in real time.
  • Static conformity. The state adopts the IRC as of a specific date and must legislatively update to adopt new changes.
  • Selective conformity. The state picks and chooses which IRC provisions to adopt.
• States that fully decouple from § 163(j).
  • California. SB 711 (enacted Oct. 1, 2025) explicitly decoupled from § 163(j) for corporate income tax, allowing full deductibility of interest. SB 1435 (introduced Mar. 11, 2026) would extend this decoupling to personal income tax retroactive to 2025.
  • Wisconsin. Adopts a pre-TCJA version of the IRC and allows full deductibility of business interest expense.
  • Georgia. Decouples from § 163(j) as amended by TCJA, applying pre-TCJA full deductibility.
  • Iowa, Kansas, Mississippi, Missouri, South Carolina, Tennessee, and Indiana also decouple, generally allowing full deductibility.
• States that decouple from OBBBA § 163(j) changes (retaining EBIT-based ATI).
  • Michigan. Public Act 24 of 2025 (signed Oct. 7, 2025) applies § 163(j) as it existed on December 31, 2024. ATI must include depreciation and amortization deductions (EBIT method, not EBITDA). This produces a more stringent limitation than federal post-OBBBA. (Michigan H.B. 4961)
  • Pennsylvania. Act 45 of 2025 (signed Nov. 12, 2025) applies § 163(j) as if in effect on December 31, 2024 (EBIT-based ATI). Pennsylvania also requires separate-company computation regardless of federal consolidated filing. (Pennsylvania Act 45 of 2025)
• Virginia partial conformity.
  • Virginia moved from rolling to fixed-date conformity (IRC as of December 31, 2025).
  • Virginia conforms to the OBBBA EBITDA-based ATI through its updated conformity date.
  • However, Virginia allows only a 20 percent state deduction for business interest disallowed under § 163(j) on the federal return (reduced from 50 percent effective for 2025). (Virginia H.B. 29 (2026), Virginia Tax Bulletin 26-1, Feb. 20, 2026)
  • Taxpayers must maintain separate Virginia records and calculate depreciation, amortization, carryforwards, and adjustments as if OBBBA changes had not been enacted.
• Florida static conformity. Florida conforms to the IRC as of January 1, 2023, and therefore does not yet conform to the OBBBA § 163(j) changes. Florida retains the EBIT-based ATI computation.
• Connecticut decoupling. Connecticut applies a pre-TCJA § 163(j) and allows full deductibility of business interest expense.
• Rolling conformity states following federal. Alabama, Alaska, Arizona, Arkansas, Colorado, Delaware, Hawaii, Idaho, Illinois, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Minnesota, Montana, Nebraska, New Hampshire, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Rhode Island, Utah, Vermont, West Virginia, and the District of Columbia generally follow the federal § 163(j) rules (including or excluding OBBBA changes depending on their specific conformity structure).
• Key planning considerations for multi-state taxpayers.
  • Compute § 163(j) separately for each state that decouples or modifies the federal rules.
  • Track state-specific carryforwards, as federal carryforwards may not carry over to states that decouple.
  • Pennsylvania requires separate-company computation. In a federal consolidated return, intercompany interest income and expense are offset. Pennsylvania taxpayers must include intercompany interest in separate entity calculations.
  • For Virginia, maintain dual books tracking the 20 percent special deduction separately.
  • Michigan and Pennsylvania taxpayers should be aware that the EBIT method produces a stricter limitation than federal EBITDA, potentially creating additional state disallowed interest even when all interest is deductible for federal purposes.
• OBBBA state revenue impact. The OBBBA restoration of EBITDA-based ATI reduces state tax revenue in conforming states because higher ATI means a larger § 163(j) limitation, more deductible interest, and lower state taxable income. States have responded by decoupling, maintaining static conformity dates, or partially limiting the benefit.