The One Big Beautiful Bill Act (OBBBA) made a permanent change to Section 163(j) of the Internal Revenue Code, restoring a more favorable way for businesses to calculate and deduct interest expense. The return of the EBITDA approach—earnings before interest, taxes, depreciation, and amortization—means many companies can now deduct a larger portion of their borrowing costs.
Understanding how this rule works is essential for business owners who rely on financing to grow or manage operations.
How the Interest Expense Limitation Works
Most businesses can deduct the interest they pay on loans used for operations, equipment, or expansion. However, Section 163(j) limits how much interest can be deducted each year. Generally, the deduction cannot exceed the total of:
- The business’s interest income;
- 30% of adjusted taxable income (ATI); and
- Any floor-plan financing interest.
The 2017 Tax Cuts and Jobs Act (TCJA) changed how businesses calculated their adjusted taxable income (ATI) by requiring depreciation, amortization, and depletion to be included. This shift reduced ATI and, in turn, limited the amount of interest companies could deduct.
Now that EBITDA is permanent, businesses can once again exclude these non-cash expenses, resulting in a higher ATI and a greater share of interest costs deductible.
What This Means for Businesses
This update is especially beneficial for companies with significant capital investments—such as manufacturers, distributors, and transportation firms—because depreciation and amortization often make up a large portion of their annual deductions. Excluding those amounts from ATI calculations gives these businesses more room to deduct their interest costs.
The limitation still applies, and any interest that exceeds the annual cap is carried forward to future years.
Floor-Plan Financing Definition Expanded
The rules for floor-plan financing interest have also been clarified and broadened. Floor-plan interest generally refers to loans used to finance inventory such as vehicles, boats, or farm equipment held for sale or lease. The definition now includes trailers and campers designed for recreational or seasonal use, intended to be towed or attached to a motor vehicle.
While this expansion allows more businesses to benefit from the deduction, it comes with a trade-off. Businesses claiming this deduction cannot also take bonus depreciation for assets placed in service during the same tax year.
Interest Capitalization and Coordination Rules
Beginning in 2026, Section 163(j) will apply to business interest expense, whether it is deducted immediately or capitalized into inventory or assets. In prior years, some taxpayers used elective capitalization to reclassify interest into categories not subject to the limitation. That strategy will no longer be effective.
Interest that must be capitalized under Section 263(g) (for certain hedges) or Section 263A(f) (for property under construction) remains excluded from this coordination rule.
Treatment of Foreign Income
For multinational companies, Section 163(j) now excludes certain foreign-related income items from the ATI calculation:
- Subpart F income under Section 951(a)
- Section 956 inclusions
- Net tested income inclusions under Section 951A
- Section 78 gross-up amounts
- Deductions under Sections 245A(a) or 250(a)(1)(B) related to these inclusions
Removing these items from ATI may reduce the amount of deductible interest for corporations with controlled foreign subsidiaries or significant foreign earnings.
Interaction with Research and Development Expenses
Section 163(j) interacts closely with the rules for research and experimental expenditures under Section 174A. Businesses that elect to expense domestic research costs immediately will reduce their ATI and could see a smaller allowable interest deduction. Those who choose to capitalize and amortize research costs may maintain a higher ATI, potentially allowing a larger interest deduction.
Further IRS guidance is expected to clarify how prior unamortized research costs will be treated in future years.
What Business Owners Should Do
Now that OBBBA has made EBITDA permanent, many businesses will be able to deduct a greater share of their borrowing costs. Coordination rules, foreign income exclusions, and research expense interactions can all influence the final deduction amount. It’s also important to understand the tax treatment in each state, as many states do not fully conform to federal rules—a topic we’ll cover in a separate blog.
Careful year-end planning—especially around financing, depreciation, and capitalization decisions—can help ensure businesses take full advantage of the deduction while staying compliant with Section 163(j). Contact your Stephano Slack tax manager or partner at 610-687-1600 or TaxInfo@StephanoSlack.com to discuss your situation.
Author: Brooke Carroll, CPA, senior manager, oversees the individual tax practice at Stephano Slack’s Wilmington, Delaware office. She brings exceptional value to client relationships by translating complex tax laws into clear, actionable guidance, helping clients navigate their tax responsibilities with confidence. With over 20 years of public accounting experience, Brooke offers a personalized approach to managing complex tax issues, particularly those involving the IRS, ensuring clients feel informed and supported throughout the process. Brooke can be reached at 302-295-1025 or bcarroll@stephanoslack.com.
Disclaimer: This content is for informational purposes only and does not constitute professional advice.
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