Planning to manage the QIP and business interest expense changes

The Coronavirus Aid, Relief, and Economic Security (CARES) Act made several changes to the Tax Cuts and Jobs Act (TCJA) intended to help taxpayers through the current economic crisis. The CARES Act corrected the TCJA’s infamous “retail glitch” affecting qualified improvement property (QIP), changing its depreciable life to 15 years from 39 years, thus making QIP eligible for bonus depreciation. This change is retroactive to 2018. The legislation also temporarily relaxed the rules on the deduction for business interest expense. The TCJA included limitations on the deduction for business interest expense that, subject to some exceptions, generally limited business interest deductions to 30% of adjusted taxable income (ATI). The CARES Act eased the restriction to 50% of ATI for 2019 and 2020, except for partnerships (see additional discussion below), where the 50% ATI allowance is only for 2020 returns. For some taxpayers, these changes are interrelated due to the exceptions under the business interest expense limitation rules for real property businesses.

First, let’s take a look at the changes.

Business interest expense limitation

Under the TCJA, taxpayers’ business interest deductions (IRC section 163(j)) are limited to 30% of ATI, plus business interest income, unless an exception applies. Exceptions include:

• Small taxpayers, generally with less than $26 million of gross receipts; however, aggregation and tax-shelter rules apply in determining eligibility for this exception
• Taxpayers with interest expense relating to floor plan financing
• Electing real property trades or businesses

For electing real property businesses as well as taxpayers with floor plan financing, the trade-off for not being subject to the business interest expense limitation is that they must use longer depreciable lives under the alternative depreciation system (ADS) for real property assets. In addition to having longer depreciable lives, assets depreciated using ADS are not eligible for bonus depreciation.

ATI is similar to earnings before interest, depreciation and amortization (EBIDA) — the two are not technically the same, but thinking of ATI as EBIDA is a good shortcut — and is calculated as follows:

Taxable income, adjusted by