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Congress Gets Clever With Partnership Business Interest Change

Posted on Mar. 27, 2020

The latest version of coronavirus relief legislation would make major tax changes to help businesses and individuals alike, and that required lawmakers to get creative in the process.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act (H.R. 748) would increase the amount of business interest companies deduct in some years and fix a major flaw in the Tax Cuts and Jobs Act that excluded qualified improvement property (QIP) from qualifying for bonus depreciation. The bill unanimously passed the Senate late March 25, and the House is expected to vote on the package March 27.

Under the TCJA, the deduction for business interest expenses under section 163(j) was limited to interest income, 30 percent of adjusted taxable income, and floor plan financing interest.

However, the coronavirus legislation would modify the net business interest deduction limit from 30 percent of ATI to 50 percent for tax years beginning in 2019 or 2020. For tax years beginning in 2020, businesses may elect to compute the interest expense limitation based on their 2019 ATI, which will likely be higher because of the economic downturn.

That means if a taxpayer has ATI of $100 in 2019 and $50 in 2020, it appears that the net interest deduction limitation would be $50 for both years, one practitioner pointed out.

But the section 163(j) changes are more complex for partnerships.

Under language in the latest bill, partnership business interest deductions would still be limited to 30 percent of ATI for 2019. However, if a partner gets suspended excess interest expense allocated to them in 2019, 50 percent of that suspended interest would be treated as “freed up” in 2020, Anthony J. Nitti of RubinBrown LLP said.

The other 50 percent of that suspended interest carryover in 2020 would still be in “section 163(j) jail,” meaning it would be be deductible only when the partner gets an allocation of excess taxable income or excess business interest income, Nitti pointed out.

For example, say a partnership has $100 of ATI in 2019 and $100 of interest expense. The deduction is limited to $30, and $70 is carried forward to 2020 as excess interest. In 2020 the partner could deduct $35 of the excess amount, but the remaining $35 would be subject to the partner excess interest income rules as usual.

Andrea Whiteway of EY said the changes to section 163(j) in the final text of the bill are quite helpful, but that some taxpayers that elected out of section 163(j) because they qualified as an excepted real property trade or business wouldn’t have elected out on their returns based on some of the changes in the final bill. That’s true in light of the section 163(j) changes, and a technical correction in the bill on bonus depreciation.

The technical correction allows QIP to qualify for 100 percent bonus depreciation retroactively to enactment of the TCJA, but that might not help partnerships that  have already filed returns with elections out of section 163(j), Whiteway said. 

The TCJA increased the deduction for bonus depreciation in section 168(k) from 50 percent to 100 percent for assets with a recovery period of 20 years or less. Another change was the reduction of improvement property classes from four categories to one, referred to as QIP. However, when Congress amended section 168(k), lawmakers forgot to give the new QIP a 15-year life, so it remained a 39-year-life property under the old rules and was not eligible for bonus depreciation.

After the TCJA was enacted, real estate businesses had a choice to make: They could elect out of the section 163(j) interest deduction limitation, but then they had to use longer depreciation periods.

That call was easier to make when QIP didn’t qualify for bonus depreciation, Whiteway said, but now taxpayers that elected out of section 163(j) on prior returns are stuck with that election and can’t take advantage of the QIP technical correction. Whiteway said she hopes Treasury will provide some relief to taxpayers regarding the irrevocability of that election.

Practitioners have suggested that one reason for the detailed partnership provisions in the CARES Act is those businesses generally can’t file amended returns as a result of the centralized partnership audit regime.

The audit regime was effective for the 2018 tax year and bars partnerships subject to it from filing amended returns; instead, they must file administrative adjustment requests. The legislation's section 163(j) workaround for partnerships could provide relief without requiring them to file amended returns, although that relief wouldn’t allow them to claim the depreciation changes made under the bill’s QIP fix.

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