OBBB Changes Affect Business Interest Expense

The tax and budget law, known as the OBBB, was signed into law on July 4 and brings significant changes in the rules governing the deductibility of business interest expense under Section 163(j). For tax years beginning after Dec. 31, 2024, the OBBB revises certain changes enacted by the Tax Cuts and Jobs Act of 2017 (TCJA) and expands the floor plan financing exception. The OBBB also makes changes to how these rules apply to capitalized business interest effective for tax years beginning after Dec. 31, 2025.

The return of an EBITDA-based Section 163(j) limitation

Generally, Section 163(j) limits the business interest deduction for taxpayers other than qualified small businesses, electing real property trades or businesses, electing farming businesses, and certain regulated public utilities. The TCJA significantly revised Section 163(j) to provide that for any taxable year the limitation is equal to the sum of:

• The taxpayer’s business interest income for the taxable year
• 30% of the taxpayer’s adjusted taxable income (ATI) for the taxable year
• The taxpayer’s floor plan financing interest expense for the taxable year

The TCJA required ATI to be calculated roughly on the basis of earnings before interest, taxes, depreciation, and amortization (EBITDA) for 2018 through 2021 tax years before switching to a calculation roughly on the basis of earnings before interest and taxes (EBIT) beginning with 2022 tax years.

The OBBB permanently returns the calculation of ATI on the basis of EBITDA for tax years beginning after Dec. 31, 2024.

Crowe observation

The change allowing EBITDA as a basis for calculating ATI can significantly increase the amount of deductible business interest expense, reducing taxable income and increasing cash flows for many businesses.

Eliminating elective capitalization

In response to the more restrictive EBIT-based ATI calculation, many taxpayers turned to elective interest capitalization strategies to preserve the deductibility of business interest expense. These strategies generally involve making an election to capitalize business interest expense under Section 266 or Section 263(a) into the cost of property (such as inventory or fixed assets). The capitalized interest then would be recovered as part of the basis of the underlying property (such as through the additional cost of goods sold or depreciation expense) and would not be subject to limitation under Section 163(j).

The OBBB eliminates these elective capitalization strategies by modifying Section 163(j) to explicitly state that the limitation applies to interest expense subject to capitalization, except for interest expense required to be capitalized under Section 263(g) (related to straddles) and Section 263A(f) (uniform capitalization [UNICAP]). However, this amendment does not apply until tax years beginning after Dec. 31, 2025, so taxpayers still might apply these elective capitalization strategies for their 2024 and 2025 tax years.

Crowe observation

The explicit language in Section 163(j) is an apparent step to prevent taxpayers from electing to capitalize interest to avoid the limitation after 2025 tax years.

Foreign income exclusion from ATI

For tax years beginning after Dec. 31, 2025, the OBBB excludes the following foreign income inclusions and related deductions from the calculation of ATI:

• Gross income under Sections 951(a) (subpart F), 951A(a) (global intangible low-taxed income [GILTI]), and 78 (foreign tax gross-up)
• Related deductions under Sections 245A(a) (by reason of Section 964(e)(4)) and 250(a)(1)(B) related to the subpart F, GILTI, and gross-up inclusions

Expanding floor plan financing exception

Generally, interest paid or accrued on floor plan financing indebtedness is not subject to the Section 163(j) business interest limitation (floor plan financing exception). Floor plan financing indebtedness is defined as indebtedness used to finance the acquisition of motor vehicles held for sale or lease and secured by the inventory so acquired. Under the TCJA, “motor vehicles” includes any self-propelled vehicle designed for transporting persons or property on a public street, highway, or road; a boat; or farm machinery or equipment. The TCJA statutory requirement that a vehicle must be self-propelled caused significant consternation to manufacturers and dealers of towable vehicles, such as campers and trailers, as these vehicles were excluded from the floor plan financing exception.

The OBBB expanded the definition of motor vehicles for tax years beginning after Dec. 31, 2025, to include any trailer or camper designed to provide temporary living quarters for recreational, camping, or seasonal use and is designed to be towed by or affixed to a motor vehicle.

Looking ahead

Taxpayers will need to model how the OBBB changes to the business interest expense limitation, particularly the shift back to an EBITDA-based limitation and the elimination of elective interest capitalization, affect their effective cost of borrowing and cash flows. Because elective capitalization is not terminated until the 2026 tax year, taxpayers should consider whether to elect to capitalize interest for their 2024 and 2025 tax years. It will be important for taxpayers to understand how these new rules interact with other provisions of the tax law in planning for the current tax year and beyond.