The Tax Cut and Jobs Act of 2017 changed how businesses can deduct their interest expenses. This has a big impact on how businesses use debt in their finances. In the past, businesses could deduct the interest they paid on their debt from their taxes, which made using debt a popular choice for financing. But the new law puts limits on how much interest businesses can deduct, which could make it more expensive for them to use debt. This is important for business owners and their advisors to know because it could affect their financial strategies. The government noticed that some businesses were using a tricky way to avoid paying taxes. They were borrowing money from foreign investors and then using the interest on that loan to avoid paying taxes on their earnings. So, Congress changed the law to make it harder for businesses to do this. Now, more businesses will have to pay taxes on their earnings, even if they borrow money from lenders who aren’t related to the business. Congress changed the tax law to make sure that all types of businesses, not just corporations, have limits on how much interest they can deduct from their taxes. This means that if a business has a lot of debt, they won’t be able to deduct as much of the interest they pay on that debt from their taxes. This could make it harder for businesses with a lot of debt to save money on their taxes. Congress created a rule that limits the amount of debt small businesses can have. But, if a small business makes less than $25 million in gross receipts, they are exempt from this rule. However, businesses that share ownership with another business might have to combine their gross receipts to see if they meet the exemption. This means that two separate businesses might be considered one for this rule. If a business shares ownership with other businesses and is considered a “tax shelter,” it may still be subject to a tax law called §163(j), even if it makes less than $25 million. A tax shelter can include partnerships where 35% or more of the losses are given to limited partners. Whether someone is a limited partner or not depends on how involved they are in managing the business. The IRS says that a business won’t be considered a tax shelter if it’s profitable, but if it has losses and 35% or more go to passive investors, it might be considered a tax shelter. So, it’s important for businesses to review their debt to make sure they get all the deductions they can. Basically, foreign investors often like to invest in Florida, especially in real estate. They usually use a mix of debt (money borrowed) and equity (their own money) to fund their investment. The interest they pay on the borrowed money can lower their taxes, and they can also usually pay it without any U.S. withholding tax. When they make a profit, they can use that money to pay back the borrowed money without generating any extra taxes. The new law §163(j) will have a big impact on foreign investments. Investors need to carefully check if their investment qualifies for any exceptions from this rule. They also need to make sure their investment doesn’t count as a tax shelter, and that the amount of money involved doesn’t exceed certain limits. If the investment is in real estate, there are special rules to consider. Real estate businesses can sometimes generate tax losses for investors, and they have a way to avoid certain tax rules by choosing a different way to depreciate their property. Basically, depreciation allows businesses to deduct the cost of their property over time to match the income they make from that property. There are two ways to do this: a faster way and a slower, more even way. Real estate businesses usually use the slower way because their property, like buildings and land, doesn’t qualify for the faster way. So, they might choose to use the slower way to depreciate their property to avoid certain tax rules that limit their interest deductions. This helps them decide if it’s worth giving up some tax deductions in the short term for more interest deductions in the long term. The new limitation on business interest deductions now applies to all businesses, not just related-party debt. Interest deductions are limited to 30% of a business’s income, but small businesses are exempt. However, there are some exceptions and caveats to be aware of. Real estate businesses may be able to avoid the limitation by using a different depreciation system. If you have a lot of interest deductions, talk to a tax advisor to understand how this new rule affects you. I.R.C. §163(j)(3) determines if a company has less than $25 million in gross receipts by looking at the rules in I.R.C. §448(c) and I.R.C. §52. These rules consider whether multiple companies should be treated as one. If two companies have 50 percent or more common ownership, they are considered related. This also applies to partnerships and other entities.
Under new I.R.C. §163(j)(3), a “tax shelter” is defined by following a path through different code sections. This definition includes any “syndicate” under I.R.C. §1256, which is a partnership or entity where more than 35 percent of the losses are allocated to limited partners or entrepreneurs who do not actively participate in managing the business. The IRS has argued about whether certain business owners should be considered limited partners or not for tax purposes. Foreign investors buying into a US company could face a high income tax rate, but there are ways to lower it. Using debt to finance business expenses can help generate tax deductions. Certain sections of the Internal Revenue Code refer to these tax rules. The matching principle is a basic accounting concept, and there’s a specific section of the tax code that applies to it. The tax code allows for deductions for using up natural resources, but not for using up land. The Tax Cuts and Jobs Act also allows for deductions for certain building improvements and equipment. There are different rules for how these deductions work, but they can still benefit taxpayers.
MICHAEL DANA is a tax advisor and this information comes from the Tax Law Section.
The Florida Bar’s goal is to teach its members about duty and serving the public, improving justice administration, and advancing legal studies.
Source: https://www.floridabar.org/the-florida-bar-journal/its-in-your-interest-new163js-limitations-on-business-interest-deductions/
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