How do new limits on business interest expense deductions affect bonus depreciation?

Pursuant to IRC Section 163(j), enacted as part of the 2017 Tax Act, businesses are now subject to an annual limitation on the deductibility of their business interest expense. This rule limits annual interest expense deductions to an amount equal to the sum of:

1. Business interest income
2. 30% of adjusted taxable income (ATI)
3. Floor plan financing interest

Floor plan financing interest is interest paid or accrued with respect to debt used to finance the acquisition of motor vehicles held for sale or lease, and that is secured by the inventory acquired. Most auto dealers that have pledged their vehicle inventory as collateral will have debts that meet the initial definition of floor plan financing. The bonus depreciation rules under IRC 168(k) include a coordination rule preventing taxpayers from claiming such accelerated depreciation if business interest was deducted under IRC 163(j) as floor plan financing interest.

Based on the statutory text several interpretational questions were raised, such as whether the annual limitation operates as a three-tier calculation or if interest otherwise meeting the floor plan definition is immediately taken into account under the floor plan tier. If such interest was initially considered floor plan financing interest, then most auto dealers would be prohibited from taking the accelerated deductions for 100% bonus depreciation. Fortunately, the recent proposed regulations clarified three key elements of the interaction between the interest expense and bonus depreciation rules:

• First, the regulations clarified that the annual limitation is a three-tier calculation. This means that an auto dealer with business interest income and 30% of ATI that exceeds all business interest expense (including floor plan) can fully deduct its interest expense and may still use bonus depreciation.
• Second, the regulations noted that this is an annual calculation, so an auto dealer’s eligibility for bonus depreciation will be determined annually based on its IRC 163(j) calculation. This is helpful because it doesn’t preclude future bonus depreciation based on interest expense in prior years.
• Third, Treasury addressed what happens when an auto dealer has more business interest expense than combined business interest income and 30% of ATI. Treasury noted that it doesn’t believe that IRC 163(j) is optional, so businesses aren’t able to elect to suspend the portion of their interest expense falling into the third tier in order to utilize bonus depreciation. In other words, a dealership can’t elect out of excluding floor plan interest from the calculation in order to be able to deduct bonus depreciation.

Certain auto dealers may find themselves benefitting from these changes more than others. For example, since Section 179 expense is allowed on $1,000,000 of qualifying additions (subject to income limitations and purchasing phaseouts), there are some businesses that may have already been able to deduct all of their qualifying purchases. However, auto dealers should consult their tax advisors to discuss the impact of Section 163(j) and the potential for final regulations or other interpretative guidance that might follow these proposed regulations. At a minimum, these regulations provide greater clarity, and are especially helpful when considering year-end planning.