Section 163(j): How the Business Interest Limitation Works

The 163(j) limitation, from IRC 163(j), caps the business interest expense a taxpayer can deduct in a year. It reaches C corporations, partnerships, S corporations and sole proprietors alike once they are over the gross receipts threshold, and it is the reason a heavily financed business can owe tax on income it spent on interest. The rules changed for tax years beginning after 2024 and again for tax years beginning after 2025, so this post works through the current formula, adjusted taxable income after P.L. 119-21, the small business exemption, the elections for real property and farming businesses, the carryforward, partnerships, and Form 8990.

The formula: interest income, 30% of ATI, floor plan interest

Business interest is interest paid or accrued on debt allocable to a trade or business; investment interest of an individual is a different limitation. Under 163(j)(1) the deduction for a tax year cannot exceed the sum of three amounts, and Form 8990 (Rev. December 2025) builds them line by line:

Adjusted taxable income after P.L. 119-21

ATI is the number the 30% applies to, so its definition decides the size of the deduction. IRC 163(j)(8) starts from taxable income and makes the adjustments in the next table. The one that matters most for capital-intensive businesses is depreciation. From 2018 through 2021 it was added back, giving an EBITDA-style base; for tax years beginning in 2022, 2023 and 2024 it was not, and ATI fell to an EBIT-style figure. Section 70303 of P.L. 119-21 struck the 2022 cutoff, so for tax years beginning after December 31, 2024 depreciation, amortization and depletion are added back again. The Form 8990 instructions confirm that line 11 has been revised to reinstate the add-back.

Two more changes take effect for tax years beginning after December 31, 2025. Section 70341 of P.L. 119-21 makes the limitation apply to business interest before any interest capitalization rule, and treats a reference to a deduction for business interest as including capitalized interest, except interest capitalized under sections 263(g) and 263A(f), which is now excluded from business interest altogether. Section 70342 takes the subpart F, section 951A and section 78 inclusions of U.S. shareholders, and the related deductions, out of ATI, which lowers the base for groups with controlled foreign corporations.

The small business exemption: $32 million for 2026

Section 163(j)(3) switches the limit off for a taxpayer, other than a tax shelter, that meets the gross receipts test of IRC 448(c): average annual gross receipts for the 3 prior tax years at or below the inflation-adjusted amount, which Rev. Proc. 2025-32 sets at $32,000,000 for tax years beginning in 2026. The Form 8990 instructions give $31 million for 2025. Three details trip people up. Gross receipts, not profit, are measured. Entities under common control are aggregated under 448(c)(2), so a group of related companies cannot split itself under the line. And a business that meets the test does not file Form 8990 at all unless it has excess business interest expense from a partnership. The exemption is applied year by year, so a growing company can move in and out of it.

Electing out: real property and farming businesses

Section 163(j)(7) excludes four kinds of trade or business: services as an employee, an electing real property trade or business (a real property development, redevelopment, construction, acquisition, conversion, rental, operation, management, leasing or brokerage business, per section 469(c)(7)(C)), an electing farming business, and certain regulated utilities. The election is made by a statement attached to a timely filed original return, including extensions, titled “Section 1.163(j)-9 Election,” naming the trade or business and its principal business activity code, per the Form 8990 instructions. Once made it is irrevocable.

The price is slower depreciation. Under IRC 168(g)(1)(F) and (g)(8), an electing real property trade or business must depreciate its nonresidential real property, residential rental property and qualified improvement property under the alternative depreciation system: 40, 30 and 20 years, straight line, instead of 39, 27.5 and 15. Because property required to use ADS is not qualified property under 168(k)(2)(D), those assets also lose bonus depreciation, which limits what a cost segregation study can do for the improvements (5- and 7-year personal property keeps its recovery periods). An electing farming business uses ADS for property with a recovery period of 10 years or more (168(g)(1)(G)). A landlord weighing the election can compare the interest saved against the lost deductions using the schedules in our guide to rental property depreciation.

Disallowed interest carries forward without expiring

Interest cut off by the limit is not lost. IRC 163(j)(2) treats it as business interest paid or accrued in the succeeding tax year, where it joins that year's interest and faces the limit again, and the statute sets no expiration. On Form 8990 the prior-year carryforward enters on line 2 and the new disallowed amount is line 31. The carryforward is separate from a net operating loss: the NOL deduction is excluded from ATI, and the two carry forward under different rules, as our NOL carryforward guide explains.

Partnerships and S corporations in one paragraph

Under 163(j)(4) the limit is applied at the partnership level. Interest the partnership can deduct is not limited again at the partner level, and the partnership's ATI is not counted twice. Interest the partnership cannot deduct becomes “excess business interest expense,” allocated to the partners, who may deduct it only in a later year in which the same partnership allocates them “excess taxable income” (unused capacity under the limit); it reduces the partner's basis when allocated. An S corporation applies the limit at the entity level and passes excess taxable income through to its shareholders. Form 8990 Part II handles the partnership computation and Part III the S corporation.

Sources: 26 U.S.C. 163(j), limitation on business interest (text current through P.L. 119-111, including P.L. 119-21 sections 70303, 70341 and 70342); 26 U.S.C. 448(c), gross receipts test; 26 U.S.C. 168(g), alternative depreciation system, including (g)(1)(F), (g)(1)(G) and (g)(8); IRS Form 8990 (Rev. December 2025), Limitation on Business Interest Expense Under Section 163(j); IRS, Instructions for Form 8990 (Rev. December 2025); IRS Rev. Proc. 2025-32, section 3.30 (2026 gross receipts test amount). Rules, thresholds and form lines checked against these sources on September 26, 2026. This is general information, not tax advice for your situation. Tax services are provided by licensed tax professionals under a separate engagement agreement. BEG does not provide tax advice.