Beware of Your Business Interest Deduction
Under the Tax Cuts and Jobs Act (“TCJA”), interest expense of a corporation is a corporate attribute. Generally, for 2018 and forward, when interest is determined to be nondeductible because it exceeds 30% of business interest income plus adjusted taxable income, (“the annual limit”) a corporation will classify the nondeductible portion of interest as a disallowed business interest carryforward. The disallowed business interest carryforward is generally deductible in future tax years, to the extent a future tax year’s interest expense is below the annual limit. The corporation is allowed to deduct the disallowed business interest carryforward up to the annual limit indefinitely.
The TCJA expanded the definition of a “loss corporation” to include any corporation with a disallowed business interest carryforward. In general, section 382 limits a loss corporation’s use of certain tax attributes following an ownership change. One important consideration provided in the recently proposed regulations is that the disallowed business interest carryforward must be utilized before any net operating loss (“NOL”) carryforward. This can potentially cause negative consequences. For example, if a corporation has NOLs from 2017 or earlier that will expire, the use of the disallowed business interest carryforward prior to the NOL carryforward could increase the chance that a portion of the NOL carryforward could expire prior to full utilization. (Carryforwards of both disallowed business interest and post-2017 NOLs do not expire, unlike pre-2018 NOL carryforwards.) Additionally, if a section 382 ownership change has occurred, the amount of the disallowed business expense carryforward may be limited.
The recently proposed regulations would extend section 382 to S corporations with a disallowed business interest carryforward. Specifically, S corporations that undergo an ownership change as defined under section 382 would be required to apply the section 382 limit to any disallowed business interest carryforward. As a result, owners and managers of S corporations should be vigilant with respect to ownership and equity shifts and consider the potential for a section 382 ownership change prior to execution of a transaction.