Definition
Section 163(j) caps the business interest expense a taxpayer may deduct in a year at the sum of business interest income, 30 percent of adjusted taxable income (ATI), and floor plan financing interest. Interest above the cap is treated as paid or accrued in the next year, so it carries forward. A taxpayer that meets the gross receipts test of section 448(c) is exempt. For tax years beginning after 2024, ATI again adds back depreciation, amortization and depletion, which raises the cap compared with the 2022 through 2024 years. The calculation is reported on Form 8990.
Why it matters in an audit or review
Highly leveraged clients can have disallowed interest that affects current tax, creates a deferred tax asset, and may need a valuation allowance. Auditors recompute ATI, test the small business exemption, and agree the carryforward to the prior-year return. Loan covenants use different definitions, so they do not substitute for the tax calculation.
Example
Illustrative: ATI is $2,000,000, business interest income is $50,000, and interest expense is $700,000. The limit is $50,000 + (30% x $2,000,000) = $650,000. Disallowed interest is $50,000. At an assumed 25% rate, the deferred tax asset is $12,500.
Common mistakes
- Using the ATI definition from the wrong year.
- Assuming a small business is exempt without testing the three-year average gross receipts.
Sources
- Internal Revenue Code section 163(j), subsections (1), (2), (3) and (8): https://www.law.cornell.edu/uscode/text/26/163
- Treasury Regulations sections 1.163(j)-1 through 1.163(j)-11
- IRS, Instructions for Form 8990
- FASB ASC 740-10-30, Initial measurement
Definitions paraphrase AICPA and FASB guidance; read the standard itself before relying on a requirement. Example figures are illustrative. This page is guidance, not professional advice. Report an error