The Internal Revenue Service's new guidance on the deduction for business interest expense has "several direct implications" for a financial advisor’s practice — both in how the advisor manages their own firm’s finances and how they advise business-owner clients, according to Jeff Bush of The Washington Update.
The IRS's fact sheet answers frequently asked questions about the Section 163(j) business interest expense limitation, which was modified under several tax laws.
The fact sheet "provides business owners with certainty about the deductibility of the business interest expense deduction for the foreseeable future," Bush said. "Heading into 2025, there was some ambiguity about the direction of tax reform, which may have discouraged business investment. When a business owner considers a long-term financed investment, clarity improves their decision-making."
Prior to the 2017 tax overhaul known as the Tax Cuts and Jobs Act, section 163(j) applied only to certain interest paid or accrued by corporations, the IRS fact sheet explains.
"However, the TCJA significantly changed the section 163(j) limitation," the IRS states, and the section was further amended by the Coronavirus Aid, Relief, and Economic Security Act, or CARES Act, released on March 27, 2020.
The Treasury Department and the IRS issued final regulations under Section 163(j) in Sept. 2020 and Jan. 2021.
Further, changes to section 163(j) were made as part of the One Big Beautiful Bill Act. "Some of the changes apply to tax years beginning after Dec. 31, 2024, while other changes become effective for tax years beginning after Dec. 31, 2025," the IRS explains.
The fact sheet addresses the section 163(j) limitation after amendments by the TCJA, the CARES Act and the OBBBA.
Impact on Advisors
Most financial advisory practices operate as pass-through entities — LLCs, S-corps or partnerships, Bush said Monday in an email.
Under the small-business safe harbor, "most independent advisors will probably qualify for the Gross Receipts Test," Bush said. "If your firm’s average annual gross receipts for the past three years are $31 million or less (for 2025), you are exempt from the 163(j) limitation. You can deduct 100% of your business interest."
As to the depreciation add-back for 2025/2026, "if your practice exceeds $31M in receipts and is therefore subject to the limitation, the new law benefits you," Bush continued. "Starting in 2025/2026, you can add back depreciation and amortization when calculating your Adjusted Taxable Income (ATI)."
If an advisor "recently invested in a large office build-out or acquired another book of business (creating amortizable intangibles), your 'allowable' interest deduction has just become significantly larger," according to Bush.
Partnership Complexity
If an advisory firm is structured as a partnership, "the limitation is calculated at the entity level," Bush said.
"If the firm has 'Excess Business Interest Expense' (EBIE), it remains with the partners until the firm generates 'Excess Taxable Income' in future years."
This is "generally a bad situation," Bush said. "It’s problematic because the deduction remains inside the partnership until they have a very profitable year. Also, if partnership A has the deduction and is not profitable, but partnership B is profitable, a partner cannot use one to offset the other."
High-Net-Worth Business Owners
Bush pointed to changes that affect advisors' business-owner clients.
- Debt-financed acquisitions: "For clients aiming to purchase competitors or equipment, the ability to deduct interest is now more certain because ATI is calculated using EBITDA-style logic (adding back depreciation and amortization) instead of the stricter EBIT-style logic used from 2022 to 2024," Bush relayed.
- Real estate clients: If an advisor advises real estate developers, "remind them of the 'Excepted Trade or Business' election," Bush said. "They can choose to opt out of the 163(j) limit entirely, but the 'cost' is using the ADS (Alternative Depreciation System), which results in slower depreciation and no bonus depreciation on certain assets."
- OBBBA Shift: Review clients with international holdings. "The new rules exclude CFC (Controlled Foreign Corporation) income from the ATI calculation for tax years after Dec 31, 2025." Bush said. "This could result in a surprise tax hit for clients who previously used offshore earnings to 'buffer' their domestic interest deductions."
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