Massachusetts releases final guidance on application of section 163(j)

On Dec. 18, 2019, the Massachusetts Department of Revenue issued its finalized technical information release providing guidance to corporate taxpayers with respect to the IRC section 163(j) excess business interest expense limitation (BIE limitation), which was implemented as part of the federal Tax Cuts and Jobs Act and applicable to tax years beginning on or after Jan. 1, 2018. Technical Information Release 19-17: Application of section 163(j) Interest Expense Limitation to Corporate Taxpayers.

What Is the BIE Limitation?

Under section 163(j), a taxpayer's business interest deduction cannot exceed the sum of:

• the taxpayer's business interest income for the tax year;

• 30% of the taxpayer's adjusted taxable income for the year; and

• the taxpayer's floor plan financing interest for the tax year.

A taxpayer can carry forward any excess BIE from the current tax year to subsequent tax years.

However, the BIE limitation does not apply to:

• taxpayers with average annual gross receipts of less than $25 million for the 3 prior tax years; or

• taxpayers engaged in certain trades.

Massachusetts Conformity with the BIE Limitation

Massachusetts follows the federal interest expense deduction under the current IRC for corporate excise tax purposes.

Taxpayers must compute the Massachusetts BIE deduction on a separate entity basis with certain modifications to account for differences in state and federal computation of income and consolidated versus combined filing requirements. The release provides the following process for determining an entity’s BIE deduction for Massachusetts tax purposes:

• If an entity’s separately determined BIE limitation exceeds the entity’s separately determined current year BIE, the entity's full current year BIE will be allowed as a deduction.
• If an entity has a carryforward of BIE, such entity’s BIE carryforward will be treated as current year BIE and will be allowed to the extent such entity’s current year BIE has not exceeded its BIE limitation.
• If an entity's separately determined current year BIE exceeds the entity’s separately determined BIE limitation, the entity's current year BIE deduction is limited to the amount of the BIE limitation. The entity’s excess BIE may be carried forward.
• Current year BIE must be used before any BIE carryforwards from prior years. Any unused current year BIE limitation cannot be carried forward.

Application of the BIE Limitation to Massachusetts Combined Groups

With respect to determining the Massachusetts deduction for BIE for a member of a Massachusetts combined group:

• Each member of a combined group must calculate its BIE and BIE limitation on a separate entity basis:

1. without regard to any federal eliminations; and
2. taking into account Massachusetts eliminations for transactions between the entity and other members of the combined group.

• A member can share current year excess BIE or excess BIE carryfowards with another group member to the extent that member has unused current year BIE limitation.
• All current year excess BIE must be utilized before any BIE carryfowards.
• Current year excess BIE that cannot be shared with another member can be carried forward to succeeding tax years on a separate entity basis.
• A member that leaves a Massachusetts combined group is allowed to keep its accrued unused BIE from prior years.
• A member that joins another Massachusetts combined group can deduct the BIE carryforward against its own separately determined income subject to its separately determined BIE limitation; however, the new member cannot share its BIE carryforward with another group member unless that member was also a member of the same group in the year that the new member incurred the BIE.

Note that while the release does not provide specific guidance as to how the $25 million small business exemption would apply to members of a Massachusetts combined group, it refers to IRC 448(c) aggregation rules, indicating that Massachusetts would likely follow federal consolidated rules and require the small business exemption to be applied on an aexpenses and costs. A taxpayer must apply the add back adjustments to its separately determined BIE on a separate entity and pre-apportioned basis. The taxpayer must first reduce current year BIE by the amount of the required add back. It cannot deduct or carry forward any amount of BIE that is disallowed due to the add back.

Interaction of the BIE Limtation with Related Member Add Back Rules

Massachusetts requires taxpayers to add back to net income related member interest expenses and costs. A taxpayer must apply the add back adjustments to its separately determined BIE on a separate entity and pre-apportioned basis. The taxpayer must first reduce current year BIE by the amount of the required add back. It cannot deduct or carry forward any amount of BIE that is disallowed due to the add back.

A number of detailed examples are provided that demonstrate the calculation of BIE limitations and BIE carryforwards for separate entities and combined groups, including the application of the Massachusetts add back rules.

Takeaways

TIR 19-17 includes important details on how to calculate the business interest expense deduction using the limitation, particularly with respect to combined groups impacted by the Massachusetts related member add back rules. All companies utilizing the Massachusetts BIE deduction should be aware that at this time, the Massachusetts Legislature has not proceeded with a proposed law  to decouple from section 163(j). Finally, regulations relating to the application of section 163(j), including how the limitation applies to personal income taxpayers and pass-through entities, are expected to be promulgated at a later date.