The Business Interest Expense Limitation (Section 163(j)): What It Means for Your Business in 2025–2026

If your business carries debt—whether it’s for real estate, expansion, equipment, or operations—understanding how much of your interest expense is actually deductible is critical.

Many business owners assume that interest is always fully deductible. That’s no longer true.

Under Section 163(j) of the Internal Revenue Code, there are limits on how much business interest you can deduct each year, and recent changes under the One, Big, Beautiful Bill have made this area even more important for tax planning in 2025 and beyond.

In this article, we break down:

• How the limitation works
• Who is affected
• Key changes for 2025–2026
• Real-world examples
• Strategic planning opportunities

What Is the Section 163(j) Limitation?

In simple terms:

Your business interest deduction may be limited to a formula—not the full amount you paid.

The general rule:

Deductible business interest =

• Business interest income
  +
• 30% of adjusted taxable income (ATI)
  +
• Floor plan financing interest (if applicable)

Anything above this limit is not lost, but carried forward to future years.

Who Is Affected?

The limitation applies to most businesses, including:

• Corporations (C-corps and S-corps)
• Partnerships
• LLCs
• Self-employed individuals

Exception: Small Businesses

You may be exempt if your business meets the gross receipts test:

• 2024 threshold: approx. $30 million
• 2025 threshold: approx. $31 million

If your average gross receipts over the past 3 years are below this level, the limitation generally does not apply.

Example: When the Limitation Applies

A business has:

• $500,000 interest expense
• $50,000 interest income
• $1,000,000 adjusted taxable income

Calculation:

• 30% of ATI = $300,000
• Total deductible = $50,000 + $300,000 = $350,000

➡️ Disallowed interest = $150,000 (carried forward)

What Is Adjusted Taxable Income (ATI)?

ATI is one of the most important parts of the calculation.

Think of it as a modified version of taxable income, adjusted for items like:

• Interest expense
• Net operating losses
• Certain deductions

Major Update (Starting 2025)

Under recent law changes:

➡️ Depreciation, amortization, and depletion are added back into ATI again

This is significant because:

• It increases ATI
• Which increases your allowable interest deduction

Example: Impact of New ATI Rules

Before 2025:

• ATI = $1,000,000
• 30% limit = $300,000

After 2025 (with $200,000 depreciation added back):

• ATI = $1,200,000
• 30% limit = $360,000

➡️ Result: $60,000 more deductible interest

What Happens to Disallowed Interest?

If your deduction is limited:

• The excess becomes a carryforward
• It can be used in future years
• But still subject to future limitations

Example: Carryforward in Practice

Year 1:

• Disallowed interest = $100,000

Year 2:

• Business has higher income
• Limitation allows full deduction

➡️ You can now deduct:

• Current year interest
• Plus prior $100,000 carryforward

Special Rules for Partnerships & S Corporations

Partnerships

• Limitation is applied at the partnership level
• Disallowed interest is passed to partners as EBIE (Excess Business Interest Expense)
• Partners can deduct it later when conditions are met

S Corporations

• Limitation is applied at the entity level
• Disallowed interest stays at the S-corp level (not passed to shareholders)

Excepted Businesses: Can You Opt Out?

Some businesses can elect out of the limitation:

Eligible industries:

• Real estate businesses
• Farming businesses
• Certain utilities

But there’s a trade-off:

If you elect out:

• You must use slower depreciation (ADS)
• You lose bonus depreciation

Example: Real Estate Strategy Decision

A real estate business:

• Has high interest expense
• Wants to avoid limitation

Option:
✔ Elect out of 163(j)

But:
✖ Must use slower depreciation
✖ Less upfront tax benefit

➡️ This becomes a strategic decision—not automatic

Floor Plan Financing Exception

Certain businesses (like dealerships) may benefit from:

• Full deduction of floor plan financing interest

Recent updates expand the definition to include:

• Trailers
• Campers
• Recreational units

2026 and Beyond: Additional Changes

Starting in 2026:

• Section 163(j) is applied before interest capitalization rules
• Certain international income items (CFC inclusions) are excluded from ATI

➡️ This can:

• Reduce ATI for some global businesses
• Potentially limit deductions further

Real-World Scenarios

Scenario 1: Growing E-commerce Business

• Increased borrowing for inventory
• Interest expense rises sharply
• Revenue fluctuates

➡️ Result:

• Partial interest disallowed
• Cash flow impact due to higher taxable income

Scenario 2: Real Estate Investor

• Significant mortgage interest
• Depreciation-heavy

➡️ Strategy:

• Evaluate electing out vs staying in system
• Compare long-term vs short-term tax savings

Scenario 3: Professional Practice Expansion

• Loans used for office expansion
• Stable income

➡️ Result:

• Likely able to fully deduct interest
• But needs monitoring as business grows past thresholds

Why This Matters for Business Owners

The Section 163(j) limitation affects:

• Cash flow
• Tax liability
• Financing decisions
• Growth strategies

Without proper planning, businesses may:

• Pay more tax than expected
• Lose valuable deductions temporarily
• Miss opportunities to optimize structure

Strategic Planning Opportunities

At Velin & Associates, Inc., we help clients proactively manage this area:

1. Timing Income & Expenses

• Increase ATI when possible
• Optimize deduction windows

2. Debt Structuring

• Evaluate how financing is structured
• Balance interest vs equity funding

3. Entity Strategy

• Partnership vs S-corp implications
• Allocation planning

4. Election Analysis

• Evaluate real estate/farming elections
• Model long-term impact

5. Forecasting

• Project future limitations
• Avoid surprises

Final Thoughts

The business interest limitation is one of the most overlooked tax rules—yet it can have a major financial impact.

With recent changes increasing flexibility in some areas (like ATI adjustments), but tightening others (like international rules), proactive tax planning is more important than ever.

Whether you’re:

• Scaling a business
• Investing in real estate
• Managing multiple income streams

Understanding how Section 163(j) applies to you can help you:
✔ Reduce taxes
✔ Improve cash flow
✔ Make smarter financial decisions

📍 Need Help Navigating Business Interest Rules?

For more information about our tax planning services, contact us today: our website 

Velin & Associates, Inc.

8159 Santa Monica Blvd STE 198/200
West Hollywood, CA 90046
📞 323-902-1000
📧 dmitriy@losangelescpa.org

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