Comment letter: proposed regulations under IRC section 163(j)

February 13, 2019

Mr. Zachary King and Ms. Meghan Howard
IRS Office of the Associate Chief Counsel
Internal Revenue Service
CC:PA:LPD:PR (REG-106089-18)
Courier's Desk, Internal Revenue Service
1111 Constitution Avenue NW
Washington, DC 20224

Dear Mr. King and Ms. Howard:

Baker Tilly Virchow Krause, LLP, on behalf of our clients, offers the following comments concerning the proposed regulations under Internal Revenue Code (“Code”) section 163(j). We recognize the enormity of the task of designing regulations across both pass-through and taxable entities, coupled with the interaction with the aggregation rules that were not designed with section 163(j) in mind.

Our comments are in the areas of (1) aggregation rules under proposed section 1.163-(j) and (2) interest capitalized under other sections of the Code.

Small Business Exception and Aggregation Rules

Proposed section 1.163(j)-6(m) provides guidance regarding partnerships and S corporations not subject to section 163(j) by reason of the small business exemption. If a partnership or S corporation is not subject to section 163(j) by reason of proposed section 1.163(j)-2(d) ($25 million gross receipts test), the exempt entity is not required to perform the business interest expense limitation calculations under proposed sections 1.163(j)-2(b) and 1.163(j)-6. However, to the extent a partner or shareholder is allocated business interest expense from an exempt entity, that business interest expense will be subject to the partner or shareholder’s own section163(j) limitation. Individual partners and shareholders are then required to apply the gross receipts test to determine whether they are subject to the section 163(j) limitation at the individual level.

Proposed section 1.163(j)-2(d)(2)(iii) provides that each partner in a partnership includes a share of partnership gross receipts in proportion to such partner’s distributive share of items of gross income that were taken into account by the partnership under section 703. With respect to shareholders in S corporations, these regulations would provide that such shareholders include a pro rata share of the S corporation’s gross receipts.

While section 163(j)(3) would apply the rules of section 448(c), we believe to apply those rules without modification is prejudicial against affected taxpayers. Specifically, the rules of section 448(c) were enacted to govern the use of the cash method of accounting. Those rules were not designed with section 163(j) in mind and, in fact, were enacted well before section 163(j) came into existence. Therefore, we believe that using the 448(c) rules, without modification, is not appropriate for determining gross receipts for section163(j) purposes.