At one time, businesses were able to claim a tax deduction for most business-related interest expense. But that changed with the enactment of the Tax Cuts and Jobs Act (TCJA). The TCJA created Section 163(j), which generally limits deductions of business interest to 30% of a company’s adjusted taxable income, with certain exceptions.

If your business has significant interest expense, it’s important to understand the impact of the deduction limit on your tax bill. The good news is there are strategies to soften the tax bite.

How it works

Unless your company is exempt from Sec. 163(j), your maximum business interest deduction for the tax year equals the sum of:

• 30% of your company’s adjusted taxable income (ATI),
• Your company’s business interest income, if any, and
• Your company’s floor plan financing interest, if any.

Assuming your company doesn’t have significant business interest income or floor plan financing interest expense, the deduction limitation is roughly equal to 30% of ATI. Note that business interest income and expense doesn’t include investment interest income or expense.

Your company’s ATI is its taxable income, excluding:

• Nonbusiness income, gain, deduction or loss,
• Business interest income or expense,
• Net operating loss deductions, and
• The 20% qualified business income deduction for pass-through entities.

When Sec. 163(j) first became law, ATI was computed without regard to depreciation, amortization or depletion. But for tax years beginning after 2021, those items are subtracted in calculating ATI, shrinking business interest deductions for companies with significant depreciable assets.

Deductions disallowed under Sec. 163(j) may be carried forward indefinitely and treated as business interest expense paid or accrued in future tax years. In subsequent tax years, the carryforward amount is applied as if it were incurred in that year, and the limitation for that year will determine how much of the disallowed interest can be deducted. Note that there are special rules for applying the deduction limit to pass-through entities, such as partnerships, S corporations and limited liability companies that are treated as partnerships for tax purposes.

Small businesses are exempt from the business interest deduction limit. These are businesses whose average annual gross receipts for the preceding three tax years don’t exceed a certain threshold amount. (There is an exception if the business is treated as a “tax shelter.”) To prevent larger businesses from splitting themselves into small entities to qualify for the exemption, certain related businesses must aggregate their gross receipts for purposes of the threshold.

Strategies for avoiding the limit

To avoid the business interest deduction limit or at least reduce its impact, some real property and farming businesses can “opt out” of the limit. The former include businesses that engage in real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing or brokerage.

Keep in mind that opting out of the interest deduction limit comes at a cost. If you opt out, you must reduce depreciation deductions for certain business property by using longer recovery periods. To determine whether opting out will benefit your business, you’ll need to weigh the tax benefits of unlimited interest deductions against the tax costs of lower depreciation deductions.

Another tax-reduction strategy is capitalizing interest expense. Capitalized interest isn’t treated as interest for purposes of the Sec. 163(j) deduction limit. The tax code allows businesses to capitalize certain overhead costs, including interest, related to the acquisition or production of property.

Interest capitalized to equipment or other fixed assets can be recovered over time through depreciation, while interest capitalized to inventory can be deducted as part of the cost of goods sold. Your tax advisor can crunch the numbers to determine whether this strategy would provide a tax advantage for your business.

You also may be able to mitigate the impact of the deduction limit by reducing your interest expense. For example, you might rely more on equity than debt to finance your business or simply pay down debts when possible. Or you could possibly generate interest income to offset some of your interest expense (for example, by extending credit to customers).

Weigh your options

If your company is affected by the business interest deduction limitation, consider taking available strategies for avoiding or minimizing its negative impact on your tax bill. Your tax advisor can help assess what’s right for your situation.

Sidebar:   Keep an eye on Congress

Unfortunately, the business interest deduction limitation isn’t one of the many provisions of the Tax Cuts and Jobs Act that are scheduled to expire at the end of 2025. But watch for developments in Congress to repeal the limitation or alleviate its impact.



For example, the Tax Relief for American Families and Workers Act of 2024 would have retroactively extended the provision that allowed businesses to disregard depreciation, amortization and depletion in computing their ATI. This bill was passed by the House in January 2024 with bipartisan support, but has since stalled in the Senate. If enacted, this change could increase interest deductions for many businesses for tax years beginning after 2021 and before 2026.