The IRS has released significant updates to its guidance on the business interest expense deduction, a complex area of tax law that has seen major shifts in recent years. This new guidance reflects changes made by the One Big Beautiful Bill Act (OBBBA) and clarifies how businesses should navigate these rules. The core of the issue revolves around Section 163(j), which limits how much business interest a company can deduct in a given year. While personal interest is rarely deductible, business interest is a different story, but it comes with restrictions. The basic rule limits the deduction to the sum of your business interest income, 30% of your adjusted taxable income, and any floor plan financing interest—which is interest on debt used to buy vehicles for your dealership or rental fleet. The new guidance explains this framework while stripping out outdated information from previous years, particularly rules related to the COVID-19 pandemic that are no longer relevant. This update is part of a continuous process of refining and clarifying tax law, and it gives businesses a clearer picture of where they stand when calculating their interest deductions.
One of the most practical questions for any business owner is whether this deduction limitation even applies to them. The good news is that there are important exceptions, particularly for smaller businesses. If your business isn’t classified as a tax shelter and your average annual gross receipts for the past three years fall below a certain threshold, you may be completely exempt from these limitations. The government adjusts this threshold for inflation each year, and it has been climbing steadily—from $30 million in 2024 to $31 million in 2025, and now to $32 million for 2026. This means more businesses might find themselves qualifying for the small business exemption as the threshold rises. There are also other categories of businesses that are completely outside the scope of these rules, such as those providing services as an employee, certain regulated utility companies, and real estate or farming businesses that make a specific election. However, that election comes with trade-offs that business owners need to carefully consider. If you elect to be treated as an excepted real property business, you generally have to use slower depreciation methods for your buildings and improvements, and you lose access to bonus depreciation. This means you’ll get smaller deductions spread out over a longer period, which might not be worth the benefit of avoiding the interest deduction limits.
Speaking of adjusted taxable income, this is where one of the most impactful changes has taken place. For tax years beginning after December 31, 2024, the calculation has reverted to what’s commonly known as an EBITDA-style approach. This means businesses can once again add back depreciation, amortization, and depletion deductions when calculating their adjusted taxable income. For a period of time—specifically for tax years between 2022 and 2024—these deductions could not be added back, which effectively lowered the ceiling on how much interest could be deducted. The restoration of these add-backs is generally good news for taxpayers because it increases the adjusted taxable income base, which in turn raises the limit on deductible business interest. The underlying mechanics involve starting with your taxable income and then making various additions and subtractions, including adding back things like business interest expense, net operating loss deductions, and certain other items. This change essentially brings back a more favorable calculation method that can free up additional interest deductions for businesses that have significant depreciation and amortization expenses, which is particularly relevant for capital-intensive industries.
The new guidance also addresses several other technical areas where changes are needed. One such area is floor plan financing, which is a specific type of borrowing used in the vehicle industry. The definition of what counts as a motor vehicle for these purposes has been expanded to include trailers and campers designed for temporary living quarters—the kind you might tow behind a truck for recreational or camping purposes. This means dealerships that finance inventory of these types of vehicles can now treat that interest as a floor plan financing expense, which is not subject to the same deduction limitations. Another important area involves how interest that’s capitalized into the cost of an asset is treated. Generally, capitalization means you’re spreading the cost over time rather than deducting it immediately, and the new rules clarify that Section 163(j) applies to all business interest expense, with some exceptions for interest capitalized under specific code sections. This confirms that businesses cannot circumvent the interest deduction limits by capitalizing interest instead of deducting it, unless it falls under a very specific carve-out. The IRS has emphasized that this isn’t a new interpretation but rather a clarification of their long-standing position, which provides some comfort to taxpayers who may have been operating under this understanding already.
International tax matters also receive attention in this updated guidance, specifically regarding controlled foreign corporations or CFCs. These are foreign corporations that are more than 50% owned by U.S. shareholders, with a U.S. shareholder being someone who owns at least 10% of the company. The tax rules for these entities are particularly complex, often requiring U.S. shareholders to include certain foreign earnings in their income even if those profits haven’t been distributed back to the United States. A new provision that takes effect for tax years beginning after December 31, 2025, changes how these income inclusions are treated in the adjusted taxable income calculation. Previously, U.S. shareholders could increase their adjusted taxable income by a portion of their CFC income inclusions, which would have the effect of increasing their business interest deduction limit. That will no longer be allowed. This is a significant change that could reduce the amount of deductible interest for U.S. companies with substantial CFC operations. The IRS has also noted that previous proposed regulations on this topic are no longer consistent with current law and shouldn’t be relied upon for future tax years. This area of the law continues to evolve, and companies with international operations will need to pay close attention to how these changes affect their tax positions.
For businesses that previously made elections to be treated as excepted trades or businesses, there’s some important transition relief available. While the basic rules for these elections haven’t changed, the IRS has issued new procedures that provide a path for some taxpayers to withdraw their elections in light of the recent changes. This is significant because these elections are generally irrevocable and binding for future tax years, with only limited exceptions. The opportunity to withdraw an election could be a valuable option for businesses that are reconsidering whether the trade-off between interest deduction limitations and depreciation rules makes sense for them. For example, a real estate company that elected to be excepted might now want to reconsider given that the adjusted taxable income calculation has become more favorable with the restoration of the EBITDA-style approach. The transition guidance is designed to give businesses a chance to reassess their positions without being locked into a decision that no longer serves their best interests. However, this decision requires careful analysis, as the interaction between the interest deduction rules and depreciation rules can be complex, and what works well for one business might be disadvantageous for another. Taxpayers should carefully evaluate their specific circumstances before deciding whether to request withdrawal of a prior election.
It’s important to understand that even with this comprehensive new guidance, we’re not at the end of the road when it comes to these rules. The IRS and Treasury Department have indicated they plan to issue additional guidance to address other changes and clarifications from the OBBBA. Furthermore, there’s an important caveat about the nature of these FAQs themselves—they are informal guidance that hasn’t been published in the Internal Revenue Bulletin, which means they cannot be relied upon or used to resolve a taxpayer’s case in the same way that formal regulations can. If the FAQs are inconsistent with the actual law as applied to a specific taxpayer’s situation, the law controls. That said, the IRS has stated that taxpayers who reasonably and in good faith rely on these FAQs may qualify for penalty relief if that reliance leads to an underpayment. But it’s crucial to understand that penalty relief doesn’t eliminate the underlying tax liability itself. Having to argue that you had reasonable cause after the IRS challenges your position is a much different scenario than having authoritative guidance that supports your position from the start. The guidance itself is found in Fact Sheet 2026-14, which replaces earlier FAQs from December 2025. Given the complexity of these rules and the potential for significant tax implications, businesses should work closely with qualified tax professionals to understand how all these changes apply to their specific situations and ensure they’re both compliant and optimizing their tax positions.
