The tax code imposes a restriction on the amount of deduction a business can take for interest expense. For the 2023 tax year, this limitation generally restricts the deduction to the sum of business interest income plus 30% of adjusted taxable income (ATI). ATI is generally taxable income without regard to business interest expense, business interest income, net operating losses, qualified business income (QBI) deduction, depreciation, amortization, and depletion. Small businesses, as defined by having average annual gross receipts of $29 million or less for the three prior tax years, are generally exempt from this limitation.
This provision is significant because it directly impacts the after-tax cost of borrowing for many businesses. The limitations can particularly affect capital-intensive businesses with significant debt. Originally enacted as part of the Tax Cuts and Jobs Act (TCJA), these limitations were designed to curb excessive borrowing and level the playing field between debt and equity financing. Prior to the TCJA, interest was generally deductible without such broad restrictions. Understanding the nuances is vital for effective tax planning and optimizing cash flow.
