IRS Updates Guidance on Business Interest Deductions

Key takeaways:

• IRS updates FAQs on business interest expense deductions under Section 163(j).
• New rules allow adding back depreciation, amortization, and depletion when calculating adjusted taxable income for tax years beginning after December 31, 2024.
• Floor plan financing now includes trailers and campers used for seasonal or recreational purposes.
• Rules apply broadly to operating companies, including those in manufacturing, distribution, technology, services, and real estate-related activities.
• Companies should review financing, transaction, and investment plans with their AAFCPAs partner to understand implications for future decisions.

The Internal Revenue Service recently clarified its Section 163(j) FAQs following changes under the One Big Beautiful Bill Act. These updates do not create new law but provide practical guidance for companies evaluating financing, merger and acquisitions activity, or capital investments. For businesses with significant depreciation or amortization, the revised framework helps align interest deductions more closely with cash flow, offering greater clarity and flexibility in planning. By reflecting operating performance rather than taxable income alone, the guidance may support more strategic borrowing, informed decision-making, and smoother execution of transactions. Especially in today’s high-interest environment, the guidance may help businesses make more informed borrowing and investment decisions while balancing financing costs and tax considerations.

What changed under Section 163(j)?

Section 163(j) limits the amount of business interest expense a taxpayer may deduct in a given year. The updated IRS guidance explains how recent legislative changes apply, organized around two effective periods.

Key changes addressed in the IRS update include:

• For tax years beginning after December 31, 2024:
  • Add back depreciation, amortization, and depletion when calculating adjusted taxable income (ATI)
  • Expand floor plan financing interest to include trailers and campers designed for temporary living use
• For tax years beginning after December 31, 2025:
  • Business interest expense is calculated before most interest capitalization provisions except Sections 263(g) and 263A(f)
  • Exclude certain controlled foreign corporation (CFC) income from ATI
  • Interest limitation aligns more closely with EBITDA-based measures
• Exemption for smaller businesses remains for companies under the inflation-adjusted gross receipts threshold

For tax years beginning after December 31, 2024, adding back depreciation, amortization, and depletion increases adjusted taxable income for many capital-intensive businesses. This change may allow a larger portion of interest expense to be deducted in the current year. For tax years beginning after December 31, 2025, the guidance further clarifies which interest expense is subject to the limitation and removes certain foreign income inclusions from the adjusted taxable income calculation.

Why This Matters for Borrowers and Deal Activity

The implications extend beyond tax compliance. Under prior rules, businesses with strong operating cash flow but heavy depreciation often found their interest deductions constrained. That disconnect became more pronounced as borrowing costs rose, particularly for companies using debt to fund acquisitions, expansions, or property-related investments.

The updated guidance addresses several practical considerations, including:

• Reducing the after-tax cost of borrowing
• Improving alignment between interest deductions and cash flow
• Affecting modeling for mergers and acquisitions, especially asset purchases
• Providing greater flexibility when pursuing accelerated depreciation
• Influencing financing decisions tied to large capital investments

In merger and acquisition transactions, asset purchases commonly generate significant depreciation and amortization. Under earlier rules, those non-cash expenses reduced adjusted taxable income and limited interest deductions, increasing the effective cost of debt. The revised calculation may ease that constraint, improving transaction economics without changing the underlying business fundamentals.

The changes also apply outside of deal activity. Companies investing in new equipment or production capacity may find the updated framework offers more flexibility when balancing depreciation strategies with financing needs. The guidance is broadly relevant to operating companies across manufacturing, distribution, technology, services, and real estate-adjacent industries and allows companies to choose the most applicable depreciation method without considering the impact on their ability to currently deduct interest costs.

How We Help

AAFCPAs provides transaction advisory and business consulting solutions that help companies navigate complex financial and strategic decisions with confidence. Our team supports buyers, sellers, and business owners in evaluating acquisitions, divestitures, real estate-related transactions, and investments, addressing tax implications and optimizing the use of business interest deductions under evolving rules. We guide clients through financial analysis, scenario modeling, and deal structuring while coordinating across accounting, tax, and operational disciplines. Beyond M&A, we assist companies investing in new equipment or expanding operations, helping balance depreciation strategies with financing needs and long-term planning objectives. Our integrated team of CPAs, CM&AAs, CExPs, consulting CFOs, and CFP® professionals collaborates with internal teams and external advisors to help reduce uncertainty, identify risks early, and provide actionable insight so business leaders may make informed decisions aligned with their goals.

These insights were contributed by Richard Weiner, CPA, MST, CM&AA, Tax Partner.

Questions? Reach out to our author directly or your AAFCPAs partner.

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