735 / Is business interest deductible when the business is a corporation?

Under prior law, business owners were typically permitted to deduct interest expenses incurred in carrying on a trade or business (subject to limitations).¹ The 2017 tax reform legislation generally limits the interest expense deduction to the sum of (1) business interest income, (2) 30 percent of the business’ adjusted taxable income and (3) floor plan financing interest (see below).² Businesses with average annual gross receipts of $31 million or less (in 2025) for the three-taxable year period that ends with the previous tax year are exempt from this new limitation (i.e., businesses that meet the gross receipts test of IRC Section 448(c)).³

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Planning Point: The IRS has released guidance on how the 2017 tax reform legislation impacts the business interest deduction limitation for consolidated groups. The limitation will apply at the consolidated group level, meaning that the group’s overall adjusted taxable income for purposes of the limitation will be its consolidated taxable income, and inter-company obligations will be disregarded.

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Further, the IRS and Treasury have released proposed regulations governing the allocation of the limitation among group members, and the treatment of disallowed interest carryforwards where a member leaves or joins the group. When one subsidiary leaves the group, the consolidated group must determine the amount of interest carryforwards that were allocated to the subsidiary. The regulations will treat an affiliated group as a single taxpayer only if it files a consolidated return for Section 163(j) purposes.⁴

“Business interest” generally excludes investment interest. It includes any interest paid or accrued on indebtedness properly allocable to carrying on a trade or business.

The final regulations released in 2020 specifically exclude commitment fees and debt issuance costs from the definition of interest. While partnership guaranteed payments and hedging gains or losses are not specifically included in the definition of business interest, examples in the regulations provide guidance on when such payments may be included. The final regulations retain substitute interest payments in the definition of interest because the payments generally are economically equivalent to interest. However, the final regulations provide that a substitute interest payment is treated as an interest expense to the payor only if the payment relates to a sale-repurchase or securities lending transaction that is not entered into by the payor in the payor’s ordinary course of business. Further, the rules provide that a substitute interest payment is treated as interest income to the recipient only if the payment relates to a sale-repurchase or securities lending transaction that is not entered into by the recipient in the recipient’s ordinary course of business.

“Business interest income” means the amount of interest that is included in the taxpayer’s gross income for the tax year that is properly allocable to carrying on a trade or business.

“Adjusted taxable income” means taxable income computed without regard to (1) items of income, gain, deduction or loss not allocable to carrying on a trade or business, (2) business interest or business interest income, (3) any net operating loss deduction (NOL), (4) the deduction for pass-through income under Section 199A and (5) for years before 2022, any deduction for depreciation, amortization or depletion.⁵ For the purpose of the business interest deduction, adjusted taxable income is computed without regard for the deductions that are allowed for depreciation, amortization or depletion for tax years beginning after December 31, 2017 and before January 1, 2022. The 2025 OBBB restored the original definition of ATI for tax years beginning after 2024.

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Planning Point: The EBITDA-type calculation restored by the OBBB is generally considered more favorable because it tends to result in a higher calculation of ATI, thus increasing the permitted business interest deduction.

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“Floor plan financing interest” is interest paid or accrued on floor plan financing indebtedness, which is indebtedness incurred to finance the purchase of motor vehicles held for sale or lease to retail customers (and secured by the inventory that is acquired).⁶ For tax years beginning in 2025 and beyond, the definition of “motor vehicle” for floor plan financing purposes in the business interest context was modified to include 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.⁷

As a result of these rules, business interest income and floor plan financing interest are fully deductible, with the limitation applying to 30 percent of the business’ adjusted taxable income.

Unused interest expense deductions may be carried forward indefinitely.⁸ The IRS has released regulations stating that the disallowance and carryfoward of a business interest deduction in the C corporation context will not affect whether (or when) the business interest expense reduces the C corporation’s earnings and profits.⁹ This means that corporations need not wait until the year in which the deduction is allowed to reduce earnings and profits.

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Planning Point: The IRS has released guidance clarifying that taxpayers with disqualified business interest that was disallowed for the last tax year beginning before January 1, 2018 may carry the interest forward as business interest to the first tax year beginning after December 31, 2017. When this interest is carried forward (i.e., to 2018 and beyond), it will be treated as any other business interest that is incurred in a year beginning after December 31, 2017. This means that the carried forward interest will be subject to the same limitations that apply to interest expenses actually incurred after the new rules became effective in 2018. Because the new law does not contain a provision providing for excess limitation carryforwards under previously applicable “super affiliation rules”, these amounts may not be carried forward to tax years beginning after December 31, 2017.¹0

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