Rev. Proc. 2020-22 Changes to the Section 163(J) Interest Limitation
On April 10th, 2020, the Internal Revenue Service posted Rev. Proc. 2020-22 to its website. This new revenue procedure provides guidance allowing taxpayers to make or revoke certain elections under Code section 163(j) and also provides guidance on the implementation of the interest limitation as revised by H.R. 748, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, Public Law No. 116-136.
The Section 163(j) Interest Limitation Under the TCJA
Code section 163(j) was modified by the Tax Cuts and Jobs Act (“TCJA”) in 2017. The new section 163(j) limited taxpayer’s business interest deductions to the sum of interest income plus 30% of adjusted taxable income (“tax EBITDA”) plus floorplan financing interest. Interest disallowed under this provision was carried forward. Certain taxpayers, such as real property trades or businesses or farmers, could make an election to take unlimited business interest deductions in the current year. These elections were irrevocable, and, in both cases, the unlimited interest deductions provided by these elections came at the cost of bonus and accelerated depreciation on certain assets. These elections were made using the rules of proposed regulation section 1.163(j)-9.
Revised Section 163(j)(7) Guidance1
The CARES Act modified section 163(j) in four ways:
- It increased the tax EBITDA limit from 30% to 50% for tax years beginning in 2019 and 2020. Under revised Code section 163(j)(10)(A)(i), this increased limit does not apply to partnerships for taxable years beginning in 2019.
- It provides that taxpayers may elect to apply the lower 30% limit in taxable years beginning in 2019 or 2020.
- It provides a special rule for partnerships where the partner treats 50% of its allocable share of a partnership’s Excess Business Interest Expense (“EBIE”) for 2019 as an interest deduction in the partner’s first taxable year beginning in 2020 without limitation. The remaining 50% gets carried forward at the partner level. Partners may elect out of this 50% EBIE rule.
- Finally, it allows taxpayers to elect to substitute its 2019 tax EBITDA for its 2020 taxable year 50% limitation.
Rev. Proc. 2020-22 provides guidance on how to make these new elections (2)
- Election Out of the 50% Tax EBITDA Limit
For the 2019 or 2020 tax year, taxpayers may elect out of the 50% by timely filing an original return, an amended return, or an Administrative Adjustment Request (“AAR”) using the 30% limit. No formal statement is required. This is an annual election that may be later revoked on an amended return or AAR.
- Election to Use 2019 Tax EBITDA in 2020
In the 2020 tax year, taxpayers may elect to use their 2019 tax EBITDA by using it instead of their 2020 tax EBITDA to compute the section 163(j) limit on a timely filed original return, amended return, or AAR. No format statement is required. The election may be revoked in a similar manner. For short 2020 taxable years, the 2019 tax EBITDA is pro-rated based on the number of months.
- Election Out of the 50% EBIE Rule
For the 2020 tax year, a partner may elect out of the 50% EBIE rule by timely filing the partner’s original return, amended return, or AAR for the first year beginning in 2020 and not applying the 50% EBIE rule in calculating the Code section 163(j) limitation. No formal statement is required, and the election may be revoked in the same manner.
Section 163(j)(7) Election Do-Overs (3)
After the TCJA and prior to the passage of the CARES Act, taxpayers treated Qualified Improvement Property (“QIP”) as 39-year property ineligible for bonus depreciation. Since changing 39-year QIP to 40-year QIP under ADS had a negligible effect on depreciation expense, taxpayers that qualified as real property trades or businesses often made the Code section 163(j)(7)(B) election to permit unlimited current, business interest deductions. Now that QIP is once again bonus eligible, taxpayers are looking at the math. Is a current unlimited interest deduction with QIP depreciated over twenty years more valuable than QIP with 100% bonus depreciation and possible disallowed interest carryovers? (There is a similar decision-making process for farmers and certain asset classes.) If the taxpayers decide that withdrawing the irrevocable election under Code section 163(j)(7)(B) is worthwhile, Rev. Proc. 2020-22 provides procedures under which they can do so. Alternatively, if a taxpayer decides that they should have made an election under section 163(j)(7) but did not do so, the revenue procedure may allow them to make a late election.
For taxable years beginning in 2018, 2019, or 2020, a taxpayer that did not file a section 163(j)(7) election with its timely filed original return or that withdrew its election under Rev. Proc. 2020-22, can file an amended return (or an AAR if applicable) to make a late election to be a qualifying farmer or real property trade or business.
- Collateral adjustments to depreciation and other items of income or expense must be made on the amended return and subsequent returns.
- The election is made on the amended return by following the statement requirements in Proposed regulation section 1.163(j)-9 and must be entitled “Revenue Procedure 2020-22 Late Section 163(j)(7) Election” and include the taxpayer’s name, address, taxpayer identification number, a description of the electing trade or business including the principal business activity code, and a statement that the taxpayer is making the election under section 163(j)(7)(B) or (C), as applicable.
- The amended return must be filed on or before October 15, 2021 unless the statute of limitations for assessment (or period for making adjustments under section 6235 for BBA partnerships) closes earlier.
For taxable years beginning in 2018, 2019, or 2020, a taxpayer that made a Code section 163(j)(7) election on its timely filed original tax return or made a late election under Rev. Proc. 2020-25. The rules mirror the procedure for late elections with the exception that the statement must state that the taxpayer is withdrawing its election under section 163(j)(7)(B).
- See Public Law No. 116-136, § 2306.
- See Rev. Proc. 2020-22, § 6.
- Rev. Proc. 2020-22, §§ 4 & 5.