Sec. 1.163(j)-4 General rules applicable to C corporations (including REITs, RICs, and members of consolidated groups) and tax-exempt corporations.
(a) Scope. This section provides rules regarding the computation of items of income and expense under section 163(j) for taxpayers that are C corporations, including, for example, members of a consolidated group, REITs, RICs, tax-exempt corporations, and cooperatives. Paragraph (b) of this section provides rules regarding the characterization of items of income, gain, deduction, or loss. Paragraph (c) of this section provides rules regarding adjustments to earnings and profits. Paragraph (d) of this section provides rules applicable to members of a consolidated group. Paragraph (e) of this section provides rules governing the ownership of partnership interests by members of a consolidated group. Paragraph (f) of this section provides cross-references to other rules within the 163(j) regulations that may be applicable to C corporations.
(b) Characterization of items of income, gain, deduction, or loss.
(1) Interest expense and interest income. Solely for purposes of section 163(j), all interest expense of a taxpayer that is a C corporation is treated as properly allocable to a trade or business. Similarly, solely for purposes of section 163(j), all interest income of a taxpayer that is a C corporation is treated as properly allocable to a trade or business. For rules governing the allocation of interest expense and interest income between excepted and non-excepted trades or businesses, see §1.163(j)-10.
(2) Adjusted taxable income. Solely for purposes of section 163(j), all items of income, gain, deduction, or loss of a taxpayer that is a C corporation are treated as properly allocable to a trade or business. For rules governing the allocation of tax items between excepted and non-excepted trades or businesses, see §1.163(j)-10.
(3) Investment interest, investment income, investment expenses, and certain other tax items of a partnership with a C corporation partner.
(i) Characterization as expense or income properly allocable to a trade or business. For purposes of section 163(j), any investment interest, investment income, or investment expense (within the meaning of section 163(d)) that a partnership pays, receives, or accrues and that is allocated to a C corporation partner as a separately stated item is treated by the C corporation partner as properly allocable to a trade or business of that partner. Similarly, for purposes of section 163(j), any other tax items of a partnership that are neither properly allocable to a trade or business of the partnership nor described in section 163(d) and that are allocated to a C corporation partner as separately stated items are treated as properly allocable to a trade or business of that partner.
(ii) Effect of characterization on partnership. The characterization of a partner’s tax items pursuant to paragraph (b)(3)(i) of this section does not affect the characterization of these items at the partnership level.
(iii) Separately stated interest expense and interest income of a partnership not treated as excess business interest expense or excess taxable income of a C corporation partner. Investment interest expense and other interest expense of a partnership that is treated as business interest expense by a C corporation partner under paragraph (b)(3)(i) of this section is not treated as excess business interest expense of the partnership. Investment interest income and other interest income of a partnership that is treated as business interest income by a C corporation partner under paragraph (b)(3)(i) of this section is not treated as excess taxable income of the partnership. For rules governing excess business interest expense and excess taxable income, see §1.163(j)-6.
(iv) Treatment of deemed inclusions of a domestic partnership that are not allocable to any trade or business. If a United States shareholder that is a domestic partnership includes amounts in gross income under sections 951(a) or 951A(a) that are not properly allocable to a trade or business of the domestic partnership, then, notwithstanding paragraph (b)(3)(i) of this section, to the extent a C corporation partner, including an indirect partner in the case of tiered partnerships, takes such amounts into account as a distributive share in accordance with section 702 and §1.702-1(a)(8)(ii), the C corporation partner may not treat such amounts as properly allocable to a trade or business of the C corporation partner.
(4) Application to RICs and REITs.
(i) In general. Except as otherwise provided in paragraphs (b)(4)(ii) and (iii) of this section, the rules in this paragraph (b) apply to RICs and REITs.
(ii) Tentative taxable income of RICs and REITs. The tentative taxable income of a RIC or REIT for purposes of calculating ATI is the tentative taxable income of the corporation, without any adjustment that would be made under section 852(b)(2) or 857(b)(2) to compute investment company taxable income or real estate investment trust taxable income, respectively. For example, the tentative taxable income of a RIC or REIT is not reduced by the deduction for dividends paid, but is reduced by the dividends received deduction (DRD) and the other deductions described in sections 852(b)(2)(C) and 857(b)(2)(A). See paragraph (b)(4)(iii) of this section for an adjustment to ATI in respect of these items.
(iii) Other adjustments to adjusted taxable income for RICs and REITs. In the case of a taxpayer that, for a taxable year, is a RIC to which section 852(b) applies or a REIT to which section 857(b) applies, the taxpayer’s ATI for the taxable year is increased by the amounts of any deductions described in section 852(b)(2)(C) or 857(b)(2)(A).
(5) Application to tax-exempt corporations. The rules in this paragraph (b) apply to a tax-exempt corporation only with respect to that corporation’s items of income, gain, deduction, or loss that are taken into account in computing the corporation’s unrelated business taxable income, as defined in section 512.
(6) Adjusted taxable income of cooperatives. Solely for purposes of computing the ATI of a cooperative under §1.163(j)-1(b)(1), tentative taxable income is not reduced by the amount of any patronage dividend under section 1382(b)(1) or by any amount paid in redemption of nonqualified written notices of allocation distributed as patronage dividends under section 1382(b)(2) (for cooperatives subject to taxation under sections 1381 through 1388), any amount described in section 1382(c) (for cooperatives described in section 1381(a)(1) and section 521), or any equivalent amount deducted by an organization that operates on a cooperative basis but is not subject to taxation under sections 1381 through 1388.
(7) Examples. The principles of this paragraph (b) are illustrated by the following examples. For purposes of the examples in this paragraph (b)(7) of this section, T is a taxable domestic C corporation whose taxable year ends on December 31; T is neither a consolidated group member nor a RIC or a REIT; neither T nor PS1, a domestic partnership, owns at least 80 percent of the stock of any corporation; neither T nor PS1 qualifies for the small business exemption in §1.163(j)-2(d) or is engaged in an excepted trade or business; T has no floor plan financing expense; all interest expense is deductible except for the potential application of section 163(j); and the facts set forth the only corporate or partnership activity.
(i) Example 1: C corporation items properly allocable to a trade or business.
(A) Facts. In taxable year 2021, T’s tentative taxable income (without regard to the application of section 163(j)) is $320x. This amount is comprised of the following tax items: $1,000x of revenue from inventory sales; $500x of ordinary and necessary business expenses (excluding interest and depreciation); $200x of interest expense; $50x of interest income; $50x of depreciation deductions under section 168; and a $20x gain on the sale of stock.
(B) Analysis. For purposes of section 163(j), each of T’s tax items is treated as properly allocable to a trade or business. Thus, T’s ATI for the 2021 taxable year is $520x ($320x of tentative taxable income + $200x business interest expense - $50x business interest income + $50x depreciation deductions = $520x), and its section 163(j) limitation for the 2021 taxable year is $206x ($50x of business interest income + 30 percent of its ATI (30 percent x $520x) = $206x). As a result, all $200x of T’s interest expense is deductible in the 2021 taxable year under section 163(j).
(C) Taxable year beginning in 2022. The facts are the same as in Example 1 in paragraph (b)(7)(i)(A) of this section, except that the taxable year begins in 2022 and therefore depreciation deductions are not added back to ATI under §1.163(j)-1(b)(1)(i)(E). As a result, T’s ATI for 2022 is $470x ($320x of tentative taxable income + $200x business interest expense - $50x business interest income = $470x), and its section 163(j) limitation for the 2022 taxable year is $191x ($50x of business interest income + 30 percent of its ATI (30 percent x $470x) = $191x). As a result, T may only deduct $191x of its business interest expense for the taxable year, and the remaining $9x is carried forward to the 2023 taxable year as a disallowed business interest expense carryforward. See §1.163(j)-2(c).
(ii) Example 2: C corporation partner.
(A) Facts. T and individual A each own a 50 percent interest in PS1, a general partnership. PS1 borrows funds from a third party (Loan 1) and uses those funds to buy stock in publicly-traded corporation X. PS1’s only activities are holding X stock (and receiving dividends) and making payments on Loan 1. In the 2021 taxable year, PS1 receives $150x in dividends and pays $100x in interest on Loan 1.
(B) Analysis. For purposes of section 163(d) and (j), PS1 has investment interest expense of $100x and investment income of $150x, and PS1 has no interest expense or interest income that is properly allocable to a trade or business. PS1 allocates its investment interest expense and investment income equally to its two partners pursuant to §1.163(j)-6(k). Pursuant to paragraph (b)(3) of this section, T’s allocable share of PS1’s investment interest expense is treated as a business interest expense of T, and T’s allocable share of PS1’s investment income is treated as properly allocable to a trade or business of T. This business interest expense is not treated as excess business interest expense, and this income is not treated as excess taxable income. See paragraph (b)(3)(iii) of this section. T’s treatment of its allocable share of PS1’s investment interest expense and investment income as business interest expense and income properly allocable to a trade or business, respectively, does not affect the character of these items at the PS1 level and does not affect the character of A’s allocable share of PS1’s investment interest and investment income.
(C) Partnership engaged in a trade or business. The facts are the same as in Example 2 in paragraph (b)(7)(ii)(A) of this section, except that PS1 also is engaged in Business 1, and PS1 borrows funds from a third party to finance Business 1 (Loan 2). In 2021, Business 1 earns $150x of net income (excluding interest expense and depreciation), and PS1 pays $100x of interest on Loan 2. For purposes of section 163(d) and (j), PS1 treats the interest paid on Loan 2 as properly allocable to a trade or business. As a result, PS1 has investment interest expense of $100x (attributable to Loan 1), business interest expense of $100x (attributable to Loan 2), $150x of investment income, and $150x of income from Business 1. PS1’s ATI is $150x (its net income from Business 1 excluding interest and depreciation), and its section 163(j) limitation is $45x (30 percent x $150x). Pursuant to §1.163(j)-6, PS1 has $55x of excess business interest expense ($100x - $45x), half of which ($27.5x) is allocable to T. Additionally, pursuant to paragraph (b)(3)(i) of this section, T’s allocable share of PS1’s investment interest expense ($50x) is treated as a business interest expense of T for purposes of section 163(j), and T’s allocable share of PS1’s investment income ($75x) is treated as properly allocable to a trade or business of T. Therefore, with respect to T’s interest in PS1, T is treated as having $50x of business interest expense that is not treated as excess business interest expense, $75x of income that is properly allocable to a trade or business, and $27.5x of excess business interest expense.
(c) Effect on earnings and profits.
(1) In general. In the case of a taxpayer that is a domestic C corporation, except as otherwise provided in paragraph (c)(2) of this section, the disallowance and carryforward under §1.163(j)-2 (and §1.163(j)-5, in the case of a taxpayer that is a consolidated group member) of a deduction for business interest expense of the taxpayer or of a partnership in which the taxpayer is a partner does not affect whether or when the business interest expense reduces the taxpayer’s earnings and profits. In the case of a foreign corporation, the disallowance and carryforward of a deduction for the corporation’s business interest expense under §1.163(j)-2 does not affect whether and when such business interest expense reduces the corporation’s earnings and profits. Thus, for example, if a United States person has elected under section 1295 to treat a passive foreign investment company (as defined in section 1297) (PFIC) as a qualified electing fund, then the disallowance and carryforward of a deduction for the PFIC’s business interest expense under §1.163(j)-2 does not affect whether or when such business interest expense reduces the PFIC’s earnings and profits.
(2) Special rule for RICs and REITs. In the case of a taxpayer that is a RIC or a REIT for the taxable year in which a deduction for the taxpayer’s business interest expense is disallowed under §1.163(j)-2(b), or in which the RIC or REIT is allocated any excess business interest expense from a partnership under section 163(j)(4)(B)(i) and §1.163(j)-6, the taxpayer’s earnings and profits are adjusted in the taxable year or years in which the business interest expense is deductible or, if earlier, in the first taxable year for which the taxpayer no longer is a RIC or a REIT.
(3) Special rule for partners that are C corporations. If a taxpayer that is a C corporation is allocated any excess business interest expense from a partnership, and if all or a portion of the excess business interest expense has not yet been treated as business interest expense by the taxpayer at the time of the taxpayer’s disposition of all or a portion of its interest in the partnership, the taxpayer must increase its earnings and profits immediately prior to the disposition by an amount equal to the amount of the basis adjustment required under section 163(j)(4)(B)(iii)(II) and §1.163(j)-6(h)(3).
(4) Examples. The principles of this paragraph (c) are illustrated by the following examples. For purposes of the examples in this paragraph (c)(4), except as otherwise provided in the examples, X is a taxable domestic C corporation whose taxable year ends on December 31; X is not a member of a consolidated group; X does not qualify for the small business exemption under §1.163(j)-2(d); X is not engaged in an excepted trade or business; X has no floor plan financing indebtedness; all interest expense is deductible except for the potential application of section 163(j); X has no accumulated earnings and profits at the beginning of the 2021 taxable year; and the facts set forth the only corporate activity.
(i) Example 1: Earnings and profits of a taxable domestic C corporation other than a RIC or a REIT.
(A) Facts. X is a corporation that does not intend to qualify as a RIC or a REIT for its 2021 taxable year. In that year, X has tentative taxable income (without regard to the application of section 163(j)) of $0, which includes $100x of gross income and $100x of interest expense on a loan from an unrelated third party. X also makes a $100x distribution to its shareholders that year.
(B) Analysis. The $100x of interest expense is business interest expense for purposes of section 163(j) (see paragraph (b)(1) of this section). X’s ATI in the 2021 taxable year is $100x ($0 of tentative taxable income computed without regard to $100x of business interest expense). Thus, X may deduct $30x of its $100x of business interest expense in the 2021 taxable year under §1.163(j)-2(b) (30 percent x $100x), and X may carry forward the remainder ($70x) to X’s 2022 taxable year as a disallowed business interest expense carryforward under §1.163(j)-2(c). Although X may not currently deduct all $100x of its business interest expense in the 2021 taxable year, X must reduce its earnings and profits in that taxable year by the full amount of its business interest expense ($100x) in that taxable year. As a result, no portion of X’s distribution of $100x to its shareholders in the 2021 taxable year is a dividend within the meaning of section 316(a).
(ii) Example 2: RIC adjusted taxable income and earnings and profits.
(A) Facts. X is a corporation that intends to qualify as a RIC for its 2021 taxable year. In that taxable year, X’s only items are $100x of interest income, $50x of dividend income from C corporations that only issue common stock and in which X has less than a twenty percent interest (by vote and value), $10x of net capital gain, and $125x of interest expense. None of the dividends are received on debt financed portfolio stock under section 246A. The DRD determined under section 243(a) with respect to X’s $50x of dividend income is $25x. X pays $42x in dividends to its shareholders, meeting the requirements of section 562 during X’s 2021 taxable year, including $10x that X reports as capital gain dividends in written statements furnished to X’s shareholders.
(B) Analysis.
(1) Under paragraph (b) of this section, all of X’s interest expense is considered business interest expense, all of X’s interest income is considered business interest income, and all of X’s other income is considered to be properly allocable to a trade or business. Under paragraph (b)(4)(ii) of this section, prior to the application of section 163(j), X’s tentative taxable income is $10x ($100x business interest income + $50x dividend income + $10x net capital gain - $125x business interest expense - $25x DRD = $10x). Under paragraph (b)(4)(iii) of this section, X’s ATI is increased by the DRD. As such, X’s ATI for the 2021 taxable year is $60x ($10x tentative taxable income + $125x business interest expense - $100x business interest income + $25x DRD = $60x).
(2) X may deduct $118x of its $125x of business interest expense in the 2021 taxable year under section 163(j)(1) ($100x business interest income + (30 percent x $60x of ATI) = $118x), and X may carry forward the remainder ($7x) to X’s 2022 taxable year. See §1.163(j)-2(b) and (c).
(3) After the application of section 163(j), X has taxable income of $17x ($100x interest income + $50x dividend income + $10x capital gain - $25x DRD - $118x allowable interest expense = $17x) for the 2021 taxable year. X will have investment company taxable income (ICTI) in the amount of $0 ($17x taxable income - $10x capital gain + $25x DRD - $32x dividends paid deduction for ordinary dividends = $0). The excess of X’s net capital gain ($10x) over X’s dividends paid deduction determined with reference to capital gain dividends ($10x) is also $0.
(4) Under paragraph (c)(2) of this section, X will not reduce its earnings and profits by the amount of interest expense disallowed as a deduction in the 2021 taxable year under section 163(j). Thus, X has current earnings and profits in the amount of $42x ($100x interest income + $50x dividend income + $10x capital gain - $118x allowable business interest expense = $42x) before giving effect to dividends paid during the 2021 taxable year.
(iii) Example 3: Carryforward of disallowed interest expense.
(A) Facts. The facts are the same as the facts in Example 2 in paragraph (c)(4)(ii)(A) of this section for the 2021 taxable year. In addition, X has $50x of interest income and $20x of interest expense for the 2022 taxable year.
(B) Analysis. Under paragraph (b) of this section, all of X’s interest expense is considered business interest expense, all of X’s interest income is considered business interest income, and all of X’s other income is considered to be properly allocable to a trade or business. Because X’s $50x of business interest income exceeds the $20x of business interest expense from the 2022 taxable year and the $7x of disallowed business interest expense carryforward from the 2021 taxable year, X may deduct $27x of business interest expense in the 2022 taxable year. Under paragraph (c)(2) of this section, X must reduce its current earnings and profits for the 2022 taxable year by the full amount of the deductible business interest expense ($27x).
(iv) Example 4: REIT adjusted taxable income and earnings and profits.
(A) Facts. X is a corporation that intends to qualify as a REIT for its 2021 taxable year. X is not engaged in an excepted trade or business and is not engaged in a trade or business that is eligible to make any election under section 163(j)(7). In that year, X’s only items are $100x of mortgage interest income, $30x of dividend income from C corporations that only issue common stock and in which X has less than a ten percent interest (by vote and value), $10x of net capital gain from the sale of mortgages on real property that is not property described in section 1221(a)(1), and $125x of interest expense. None of the dividends are received on debt financed portfolio stock under section 246A. The DRD determined under section 243(a) with respect to X’s $30x of dividend income is $15x. X pays $28x in dividends meeting the requirements of section 562 during X’s 2021 taxable year, including $10x that X properly designates as capital gain dividends under section 857(b)(3)(B).
(B) Analysis.
(1) Under paragraph (b) of this section, all of X’s interest expense is considered business interest expense, all of X’s interest income is considered business interest income, and all of X’s other income is considered to be properly allocable to a trade or business. Under paragraph (b)(4)(ii) of this section, prior to the application of section 163(j), X’s tentative taxable income is $0 ($100x business interest income + $30x dividend income + $10x net capital gain - $125x business interest expense - $15x DRD = $0). Under paragraph (b)(4)(iii) of this section, X’s ATI is increased by the DRD. As such, X’s ATI for the 2021 taxable year is $40x ($0 tentative taxable income + $125x business interest expense - $100x business interest income + $15x DRD = $40x).
(2) X may deduct $112x of its $125x of business interest expense in the 2021 taxable year under section 163(j)(1) ($100x business interest income + (30 percent x $40x of ATI) = $112x), and X may carry forward the remainder of its business interest expense ($13x) to X’s 2022 taxable year.
(3) After the application of section 163(j), X has taxable income of $13x ($100x business interest income + $30x dividend income + $10x capital gain - $15x DRD - $112x allowable business interest expense = $13x) for the 2021 taxable year. X will have real estate investment trust taxable income (REITTI) in the amount of $0 ($13x taxable income + $15x of DRD - $28x dividends paid deduction = $0).
(4) Under paragraph (c)(2) of this section, X will not reduce earnings and profits by the amount of business interest expense disallowed as a deduction in the 2021 taxable year. Thus, X has current earnings and profits in the amount of $28x ($100x business interest income + $30x dividend income + $10x capital gain - $112x allowable business interest expense = $28x) before giving effect to dividends paid during X’s 2021 taxable year.
(v) Example 5: Carryforward of disallowed interest expense.
(A) Facts. The facts are the same as in Example 4 in paragraph (c)(4)(iv)(A) of this section for the 2021 taxable year. In addition, X has $50x of mortgage interest income and $20x of interest expense for the 2022 taxable year. X has no other tax items for the 2022 taxable year.
(B) Analysis. Because X’s $50x of business interest income exceeds the $20x of business interest expense from the 2022 taxable year and the $13x of disallowed business interest expense carryforwards from the 2021 taxable year, X may deduct $33x of business interest expense in 2022. Under paragraph (c)(2) of this section, X must reduce its current earnings and profits for 2022 by the full amount of the deductible interest expense ($33x).
(d) Special rules for consolidated groups.
(1) Scope. This paragraph (d) provides rules applicable to members of a consolidated group. For all members of a consolidated group for a consolidated return year, the computations required by section 163(j) and the regulations in this part under section 163(j) are made in accordance with the rules of this paragraph (d) unless otherwise provided elsewhere in the section 163(j) regulations. For rules governing the ownership of partnership interests by members of a consolidated group, see paragraph (e) of this section.
(2) Calculation of the section 163(j) limitation for members of a consolidated group.
(i) In general. A consolidated group has a single section 163(j) limitation, the absorption of which is governed by §1.163(j)-5(b)(3)(ii).
(ii) Interest. For purposes of determining whether amounts, other than amounts in respect of intercompany obligations (as defined in §1.1502-13(g)(2)(ii)), intercompany items (as defined in §1.1502-13(b)(2)), or corresponding items (as defined in §1.1502-13(b)(3)), are treated as interest within the meaning of §1.163(j)-1(b)(22), all members of a consolidated group are treated as a single taxpayer.
(iii) Calculation of business interest expense and business interest income for a consolidated group. For purposes of calculating the section 163(j) limitation for a consolidated group, the consolidated group’s current-year business interest expense and business interest income, respectively, are the sum of each member’s current-year business interest expense and business interest income, including amounts treated as business interest expense and business interest income under paragraph (b)(3) of this section.
(iv) Calculation of adjusted taxable income. For purposes of calculating the ATI for a consolidated group, the tentative taxable income is the consolidated group’s consolidated taxable income, determined under §1.1502-11 but without regard to any carryforwards or disallowances under section 163(j). Further, for purposes of calculating the ATI of the group, intercompany items and corresponding items are disregarded to the extent that they offset in amount. Thus, for example, certain portions of the intercompany items and corresponding items of a group member engaged in a non-excepted trade or business will not be included in ATI to the extent that the counterparties to the relevant intercompany transactions are engaged in one or more excepted trades or businesses.
(v) Treatment of intercompany obligations.
(A) In general. Except as otherwise provided in paragraph (d)(2)(v)(B) of this section, for purposes of determining a member’s business interest expense and business interest income, and for purposes of calculating the consolidated group’s ATI, all intercompany obligations, as defined in §1.1502-13(g)(2)(ii), are disregarded. Therefore, except as otherwise provided in paragraph (d)(2)(v)(B) of this section, interest expense and interest income from intercompany obligations are not treated as business interest expense and business interest income.
(B) Repurchase premium. This paragraph (d)(2)(v)(B) applies if a member of a consolidated group purchases an obligation of another member of the same consolidated group in a transaction to which §1.1502-13(g)(5) applies. Notwithstanding the general rule of paragraph (d)(2)(v)(A) of this section, if, as a result of the deemed satisfaction of the obligation under §1.1502-13(g)(5)(ii), the debtor member has repurchase premium that is deductible under §1.163-7(c), such repurchase premium is treated as interest that is subject to the section 163(j) limitation. See §1.163(j)-1(b)(22)(i)(H).
(3) Investment adjustments. For rules governing investment adjustments within a consolidated group, see §1.1502-32(b).
(4) Examples. The principles in this paragraph (d) are illustrated by the following examples. For purposes of the examples in this paragraph (d)(4), S is a member of the calendar-year consolidated group of which P is the common parent; the P group does not qualify for the small business exemption in §1.163(j)-2(d); no member of the P group is engaged in an excepted trade or business; all interest expense is deductible except for the potential application of section 163(j); and the facts set forth the only corporate activity.
(i) Example 1: Calculation of the section 163(j) limitation.
(A) Facts. In the 2021 taxable year, P has $50x of separate tentative taxable income after taking into account $65x of interest paid on a loan from a third party (without regard to any disallowance under section 163(j)) and $35x of depreciation deductions under section 168. In turn, S has $40x of separate tentative taxable income in the 2021 taxable year after taking into account $10x of depreciation deductions under section 168. S has no interest expense in the 2021 taxable year. The P group’s tentative taxable income the 2021 taxable year is $90x, determined under §1.1502-11 without regard to any disallowance under section 163(j).
(B) Analysis. As provided in paragraph (b)(1) of this section, P’s interest expense is treated as business interest expense for purposes of section 163(j). If P and S were to apply the section 163(j) limitation on a separate-entity basis, then P’s ATI would be $150x ($50x + $65x + $35x = $150x), its section 163(j) limitation would be $45x (30 percent x $150x = $45x), and a deduction for $20x of its $65x of business interest expense would be disallowed in the 2021 taxable year under section 163(j). However, as provided in paragraph (d)(2) of this section, the P group computes a single section 163(j) limitation, and that computation begins with the P group’s tentative taxable income (as determined prior to the application of section 163(j)), or $90x. The P group’s ATI is $200x ($50x + $40x + $65x + $35x + $10x = $200x). Thus, the P group’s section 163(j) limitation for the 2021 taxable year is $60x (30 percent x $200x = $60x). As a result, all but $5x of the P group’s business interest expense is deductible in the 2021 taxable year. P carries over the $5x of disallowed business interest expense to the succeeding taxable year.
(ii) Example 2: Intercompany obligations.
(A) Facts. On January 1, 2021, G, a corporation unrelated to P and S, lends P $100x in exchange for a note that accrues interest at a 10 percent annual rate. A month later, P lends $100x to S in exchange for a note that accrues interest at a 12 percent annual rate. In 2021, P accrues and pays $10x of interest to G on P’s note, and S accrues and pays $12x of interest to P on S’s note. For that year, the P group’s only other items of income, gain, deduction, and loss are $40x of income earned by S from the sale of inventory, and a $30x deductible expense arising from P’s payment of tort liability claims.
(B) Analysis. As provided in paragraph (d)(2)(v) of this section, the intercompany obligation between P and S is disregarded in determining P and S’s business interest expense and business interest income and in determining the P group’s ATI. For purposes of section 163(j), P has $10x of business interest expense and a $30x deduction for the payment of tort liability claims, and S has $40x of income. The P group’s ATI is $10x ($40x - $30x = $10x), and its section 163(j) limitation is $3x (30 percent x $10x = $3x). The P group may deduct $3x of its business interest expense in the 2021 taxable year. A deduction for P’s remaining $7x of business interest expense is disallowed in the 2021 taxable year, and this amount is carried forward to the 2022 taxable year.
(e) Ownership of partnership interests by members of a consolidated group.
(1) [Reserved]
(2) Change in status of a member. A change in status of a member (that is, becoming or ceasing to be a member of the group) is not treated as a disposition for purposes of section 163(j)(4)(B)(iii)(II) and §1.163(j)-6(h)(3).
(3) Basis adjustments under §1.1502-32. A member’s allocation of excess business interest expense from a partnership and the resulting decrease in basis in the partnership interest under section 163(j)(4)(B)(iii)(I) is not a noncapital, nondeductible expense for purposes of §1.1502-32(b)(3)(iii). Additionally, an increase in a member’s basis in a partnership interest under section 163(j)(4)(B)(iii)(II) to reflect excess business interest expense not deducted by the consolidated group is not tax-exempt income for purposes of §1.1502-32(b)(3)(ii). Investment adjustments are made under §1.1502-32(b)(3)(i) when the excess business interest expense from the partnership is converted into business interest expense, deducted, and absorbed by the consolidated group. See §1.1502-32(b).
(4) Excess business interest expense and §1.1502-36. Excess business interest expense is a Category D asset within the meaning of §1.1502-36(d)(4)(i).
(f) Cross-references. For rules governing the treatment of disallowed business interest expense carryforwards for C corporations, including rules governing the treatment of disallowed business interest expense carryforwards when members enter or leave a consolidated group, see §1.163(j)-5. For rules governing the application of section 163(j) to a C corporation or a consolidated group engaged in both excepted and non-excepted trades or businesses, see §1.163(j)-10.
(g) Applicability date.
(1) In general. This section applies to taxable years beginning on or after November 13, 2020. However, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may choose to apply the rules of this section to a taxable year beginning after December 31, 2017, so long as the taxpayers and their related parties consistently apply the rules of the section 163(j) regulations, and, if applicable, §§1.263A-9, 1.263A-15, 1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.469-9, 1.469-11, 1.704-1, 1.882-5, 1.1362-3, 1.1368-1, 1.1377-1, 1.1502-13, 1.1502-21, 1.1502-36, 1.1502-79, 1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of §§1.382-2, 1.382-5, 1.382-6, and 1.383-1), and 1.1504-4, to that taxable year.
(2) [Reserved]
[Added by T.D. 9905, 85 FR 56686-56845, Sept. 14, 2020.]
