Changes to Business Interest Deductions Could Benefit Some Taxpayers

Businesses can usually deduct interest paid or accrued for federal taxes, but limits may apply. Upcoming changes this year will expand deductions for some businesses.

Understanding The Basic Limitation

Typically, businesses can only deduct 30% of their adjusted taxable income (ATI) as interest expense each year. This limitation applies to individuals and various business types, such as partnerships, LLCs, and C or S corporations.

If a business's interest expense exceeds this threshold, the excess amount isn't forfeited; instead, it can generally be carried forward to future tax years.

Business interest expense includes any interest paid on debts tied to business operations. For partnerships, LLCs treated as partnerships, and S corporations, the limit is first determined at the entity level, then applied to individual owners based on specific rules.

The interest deduction limitation is also applied before certain other tax restrictions, including:

• Passive activity loss (PAL) rules

• At-risk limitations

• Excess business loss disallowance rules

For pass-through entities, these additional rules are typically applied at the owner level.

Key Changes Beginning In 2025

There are two significant developments underway that may result in an increase in deductible business interest.

1. ATI

Beginning with the 2025 tax year, ATI will be calculated before deductions for depreciation, amortization, and depletion. This change aligns ATI more closely with the financial accounting concept of EBITDA (earnings before interest, taxes, depreciation, and amortization).

Because depreciation and similar deductions are added back when calculating ATI, the change generally increases ATI, which may allow businesses to deduct more interest expense.

2. Floor Plan Financing

The law broadens the definition of floor plan financing in 2025 to include loans for trailers and campers designed as temporary living quarters for recreation or seasonal use. Businesses using this financing may benefit from higher interest deductions.

Exceptions to the Limitation

Several types of businesses are exempt from the business interest expense limitation.

Small businesses can be exempt if their average annual gross receipts over the previous three years remain below the inflation-adjusted limits: $31 million for the 2025 tax year and $32 million for the 2026 tax year.

Certain businesses are exempt from the business interest expense limitation, including electing real property and farming businesses that opt for longer depreciation schedules, and regulated utility providers such as electricity or water companies. Real estate and farming businesses should weigh the benefit of higher current interest deductions against slower depreciation.

Bottom Line

The regulations on business interest expense deductions are complicated, and recent changes in legislation make things even more challenging for businesses. If your company could be impacted by these new rules, seeking advice from a professional can clarify how the changes might affect your tax situation.