The IRS updated guidance on 19 August 2026 for section 163(j) business interest deduction limits, with the One, Big, Beautiful Bill Act restoring depreciation add-backs to adjusted taxable income calculations effective 2025 and excluding controlled foreign corporation income inclusions from that calculation starting 2026.
The US IRS has published updated Questions and Answers about the limitation on the deduction for business interest expense, dated 19 August 2026. The updated FAQs are as follows:
Topic A: General information
Q1. What is the section 163(j) limitation on the deduction for business interest expense? (updated 19 August 2026)
A1. Generally, taxpayers can deduct interest expense paid or accrued in the taxable year. However, if the section 163(j) limitation applies, the amount of deductible business interest expense in a taxable year cannot exceed 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; and
- The taxpayer’s floor plan financing interest expense for the taxable year.
Q3. What is the gross receipts test for purposes of the section 163(j) limitation? (updated 19 August 2026)
A3. A business generally meets the gross receipts test of section 448(c) for a taxable year when it is not a tax shelter (as defined in section 448(d)(3)) and has average annual gross receipts of USD 25 million or less in the previous three years. The USD 25 million gross receipts amount is adjusted annually for inflation. The inflation adjusted gross receipts amount for 2024 is USD 30 million. The inflation adjusted gross receipts amount for 2025 is USD 31 million. The inflation adjusted gross receipts amount for 2026 is USD 32 million.
Topic B: Excepted trades or businesses
Q2. How does an eligible real property trade or business or farming business elect to be an excepted trade or business? (updated 19 August 2026)
A2. A taxpayer with an eligible real property trade or business or farming business may make an election to be an excepted trade or business by following the procedures outlined in Treas. Reg. §1.163(j)-9, including the requirement to attach a statement to a timely filed federal income tax return (including any extensions) for the taxable year of election. See also Revenue Procedures 2018-59, 2021-9, and 2026- 17. An exempt small business is permitted to make an election to be an excepted trade or business even though that taxpayer is not subject to the section 163(j) limitation. See Treas. Reg. §§1.163(j)-2(d)(1) and 1.163(j)-9(b). This provision is intended to allow taxpayers who are unsure whether they qualify as an exempt small business to make a protective election without having to apply the gross receipts test described in Topic A: Q 2 and 3 above for the prior three taxable years.
Once made, an election is generally irrevocable and binding on the trade or business for all succeeding years. See Treas. Reg.§1.163(j)-9 for certain circumstances where the election terminates. See also Revenue Procedure 2026-17 for certain circumstances where the election may be withdrawn. The statement making an election to be an excepted trade or business that is attached to the taxpayer’s return for the taxable year of election must include the following information:
- The taxpayer’s name, address, and social security number or employer identification number;
- A description of the electing trade or business, including the principal business activity code; and
- A statement that the taxpayer is making an election as a real property trade or business (under section 163(j)(7)(B) or as a farming business (under section 163(j)(7)(C)), as applicable.
Q3. Are there any consequences I should be aware of in making an election to be an excepted trade or business? (updated 19 August 2026)
A3. Yes. If you make an election to be an excepted real property trade or business, the following assets that you hold in the electing real property trade or business must be depreciated using the alternative depreciation system (ADS) and are not eligible for a bonus depreciation deduction under section 168(k):
- Nonresidential real property;
- Residential rental property; and
- Qualified improvement property.
If you make an election to be an electing farming business, any property with a recovery period of 10 years or more that you hold in the electing farming business must be depreciated using ADS, and such property is not eligible for a bonus depreciation deduction under section 168(k).
Topic C: Determining the section 163(j) limitation amount
Q2. What is business interest expense? (updated 19 August 2026)
A2. Business interest expense is any interest expense that is properly allocable to a trade or business that is not an excepted trade or business. As discussed in Topic D: Q 1, section 163(j) applies to all business interest expense without regard to any mandatory or elective interest capitalisation provisions, except for interest capitalised under section 263(g) or 263A(f). Accordingly, business interest expense excludes any interest capitalised under section 263(g) or 263A(f) and includes all other interest expense that is allocable to a trade or business that is not an excepted trade or business. Floor plan financing interest expense is also business interest expense.
Q4. How do I calculate ATI (ATI limitation)? (updated 19 August 2026)
A4. ATI is calculated by taking the taxable income for the taxable year as if section 163(j) does not limit any interest deduction, and then adding and subtracting from that amount certain amounts for the taxable year:
Additions include, but are not limited to, business interest expense; net operating loss deduction; deduction for qualified business income under section 199A; depreciation, amortisation, or depletion deduction for taxable years beginning before 1 January 2022, or after 31 December 2024; capital loss carrybacks or carryovers; and any deduction or loss not properly allocable to a non-excepted trade or business.
Subtractions include, but are not limited to, business interest income; floor plan financing interest expense; with respect to the sale or other disposition of property (which may take place in a taxable year beginning on or after 1 January 2022), the greater of the allowed or allowable depreciation, amortization or depletion of the property for taxable years beginning before 1 January 2022, or after 31 December 2024; and any income or gain that is not properly allocable to a non-excepted trade or business.
Q5. What is floor plan financing interest expense? (updated 19 August 2026)
A5. Floor plan financing interest expense is interest paid or accrued on floor plan financing indebtedness. Floor plan financing indebtedness is indebtedness that is used to finance the acquisition of motor vehicles held for sale or lease and that is secured by the acquired inventory. For example, if you own an automobile dealership and pay interest on a loan that is secured by the dealership’s office equipment, then such interest is not a floor plan financing interest expense since it is not secured by the acquired inventory.
For purposes of floor plan financing, a motor vehicle is defined as any one of the following:
- A self-propelled vehicle designed for transporting persons or property on a public street,
- A boat, and
- Farm machinery or equipment
As discussed in Topic D: Q 1, for tax years beginning after December 31, 2024, a motor vehicle, for purposes of determining whether interest is floor plan financing interest, also includes any trailer or camper which is 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.
Q6. What happens to business interest expense that I cannot deduct in the current year because of the section 163(j) limitation? (updated 19 August 2026)
A6. The amount of business interest expense disallowed as a deduction in the current year under section 163(j) is carried forward to the next taxable year (a “disallowed business interest expense carryforward”). Your disallowed business interest expense carryforward may be limited in the next taxable year if the section 163(j) limitation continues to apply to you. Special rules apply to partnerships and S Corporations.
Q8. How does the section 163(j) limitation apply to partnerships and S corporations? (updated 19 August 2026)
A8. The section 163(j) limitation is applied at the partnership level. As provided in Topic A: Q 1, the amount of deductible business interest expense in a taxable year cannot exceed the sum of the partnership’s business interest income, 30% of the partnership’s ATI, and the partnership’s floor plan financing interest expense.
Business interest expense that may be deducted upon application of the section 163(j) limitation is taken into account in determining the non-separately stated taxable income or loss of the partnership. Any business interest expense of the partnership that is disallowed upon application of the section 163(j) limitation is allocated to each partner in the same manner as the non-separately stated taxable income or loss of the partnership. This amount is called excess business interest expense (EBIE).
Q11. Does the section 163(j) limitation apply to foreign corporations? (updated 19 August 2026)
A11. Yes, the section 163(j) limitation applies to any foreign corporation whose classification is relevant under Treas. Reg. §301.7701-3(d)(1) for a taxable year other than solely pursuant to section 881 or 882. As a result, section 163(j) applies to any foreign corporation that is a controlled foreign corporation (CFC).
Generally, section 163(j) applies to a CFC in the same manner as it applies to a domestic C corporation. If a CFC is a partner in a partnership, the section 163(j) limitation applies to the partnership in the same manner as if the CFC were a domestic C corporation. Treas. Reg. §1.163(j)-7 provides rules for determining the amount of ATI and calculating the limitation for CFCs. If a CFC group election is in effect, a single section 163(j) limitation is computed for the CFC group under rules provided in Treas. Reg. §1.163(j)-7(c). In addition, if a CFC or CFC group is eligible for a safe harbour election, none of the CFC’s or CFC group members’ business interest expense is disallowed in a taxable year for which the election is made. See Revenue Procedure 2026-17 for additional information.
Section 163(j) also applies to any foreign corporation (or other foreign person) that is engaged in a US trade or business. Prop. Reg. §1.163(j)-8 provides rules for determining the amount of ATI and calculating the limitation for the foreign corporation (or other foreign person). In the case of a foreign corporation engaged in a US trade or business, the proposed regulations coordinate the application of section 163(j) with the rules for allocating interest expense to income effectively connected with a US trade or business.
Topic D: One, Big, Beautiful Bill Act changes and clarifications
Q1. What changes and clarifications were made under the One, Big, Beautiful Bill Act? (updated 19 August 2026)
A1. Taxpayers should be aware of four changes and clarifications made by the One, Big, Beautiful Bill Act regarding section 163(j).
First, for tax years beginning after 31 December 2024, the One, Big, Beautiful Bill Act amended section 163(j) to add back deductions for depreciation, amortisation, or depletion to taxable income when calculating ATI. For taxable years beginning after 31 December 2021, and before 1 January 2025, these amounts were not allowed to be added back to taxable income in calculating ATI.
Second, for tax years beginning after 31 December 2024, the One, Big, Beautiful Bill Act revised the definition of a motor vehicle, for purposes of determining whether interest is floor plan financing interest, so that it includes any trailer or camper which is 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.
Third, the One, Big, Beautiful Bill Act clarified that, except for interest that is capitalised under sections 263(g) or 263A(f), section 163(j) applies to all business interest expense regardless if any portion would otherwise be deducted or capitalised under a mandatory or elective interest capitalisation provision. Accordingly, business interest expense excludes any interest capitalised under section 263(g) or 263A(f) and includes all other business interest expense. These clarifications do not reflect a change in Treasury and IRS position.
Fourth, for tax years beginning after 31 December 2025, the One, Big, Beautiful Bill Act amended section 163(j) to exclude a US shareholder’s CFC income inclusion items under sections 951(a), 951A(a), and 78 (including associated portions of deductions) from the computation of ATI. As a result of this change, a US shareholder will no longer be allowed to increase its ATI by a portion of CFC income inclusions.
Accordingly, the proposed regulations under Treas. Reg. § 1.163(j)-7(j) that were issued in September 2020 are no longer consistent with current law and taxpayers can no longer rely on them for tax years beginning after 31 December 2025. The Department of Treasury and the IRS plan to issue guidance that addresses these changes and clarifications to section 163(j).
Q2. What effect do changes and clarifications made under the One, Big, Beautiful Bill Act have on elections to be an excepted trade or business? (updated 19 August 2026)
A2. The One, Big, Beautiful Bill Act did not change or otherwise clarify the rules for making an election to be treated as an excepted trade or business under Treas. Reg. sections 1.163(j)-9 and 1.163(j)- 1(b)(15)(iii). However, Revenue Procedure 2026-17 provides transition guidance for taxpayers who previously made these elections but now want to withdraw them in light of the One, Big, Beautiful Bill Act changes to section 163(j)(8).
