Business Interest Expense Limitations

As Nate mentioned last week in his early tax planning post, one of the big changes for 2022 is the limitation for business interest expense. While the law may not be new (it’s been around since the Tax Cuts and Jobs Act in 2017), it’s likely going to be the first time it will have an impact on many transportation companies. The interest deduction limitation was 30% of “adjusted taxable income” (ATI) in 2017 and 2018, and was increased to 50% in 2019 and 2020 as part of the COVID response. However, for most companies there will be a change in the definition of ATI effective January 1, 2022 (taxpayers can no longer include depreciation and amortization expense – here is a good article explaining the basics of how this works). In talking to clients, prospects, and business leaders over the past few months, this is coming as a huge surprise to them.

Given that transportation is a heavy asset business, there is typically a lot of depreciation computed in taxable income. This effectively made the limitation nonexistent for most companies the last few years as they would have had a relatively high ATI with the depreciation expense included.

Let’s walk through an example of how this law could impact your tax situation this year:

ABC Trucking, Inc. is an S Corporation with one owner. ABC had $30,000,000 of revenues and $1,000,000 of taxable income in 2021. Included in the net income was $600,000 of interest expense and $3,000,000 of tax depreciation. ABC is projecting an identical year in 2022 as they did in 2021.

In 2021, ABC gets to include the $3,000,000 of depreciation expense in the ATI calculation which allowed them to deduct the full amount of $600,000 interest expense. With the law change in 2022, ABC no longer is allowed to include the depreciation expense. This drastically reduces the amount of ATI, and limits the amount of interest expense that ABC can deduct to $480,000 leaving $120,000 of interest expense as non-deductible on the 2022 tax return. If ABC’s shareholder has an effective tax rate (Federal and state) of 35%, this would increase the tax bill by approximately $42,000 in 2022!

There are a lot of things to consider and plan around with the business interest limitations, so be sure to reach out to your advisor earlier than normal to see how these changes may impact your business.