What Limitations Has the IRS Placed on Tax Deductions for Business Interest?

 Posted on September 09, 2026 in Taxation Law

When businesses determine the taxes they are required to pay, they will need to understand the deductions that can be claimed. These deductions can significantly reduce a business’s tax bill, but multiple types of complex laws and rules determine what deductions may apply. One important deduction involves business interest, which allows a business to treat interest paid on debts as a deductible expense. Some recent changes have been made to the rules for business interest deductions, so taxpayers will need to understand what limitations may apply.

Determining how to address the business tax issues that may affect the amount of taxes that must be paid and the deductions that can be claimed can be difficult. In situations where a business owner or other stakeholders are unsure about their options, legal guidance from an experienced tax attorney can be essential. A lawyer can make sure a business meets its legal requirements, and they can also provide representation during tax audits or when addressing penalties that have been assessed by the IRS.

Understanding Limitations on Deductions for Business Interest Expenses

When a business has paid interest on loans during a tax year, it can claim deductions for these expenses. However, Section 163(j) of the Internal Revenue Code details the limitations that apply to these deductions. The total amount of deductible business interest expenses cannot be higher than the sum of the following in the same tax year:

• The total amount of income the business earned through business interest.
• 30% of the business’s adjusted taxable income (ATI).
• Any interest expenses for the business’s floor plan financing.

ATI is calculated by taking a business’s taxable income in a tax year and adding and subtracting certain figures. Additions may include business interest expenses, net operating loss deductions, deductions for qualified business income, carrybacks or carryovers for capital losses, and deductions for depreciation, depletion, or amortization. Subtractions may include income from business income, expenses for floor plan financing interest, and depreciation, depletion, or amortization of property that has been sold.

Floor plan financing may include debts related to the sale or lease of vehicles used by a business in which the vehicles are used as collateral to secure the debts. Applicable vehicles may include motor vehicles like cars or trucks, boats, farm equipment, or campers or trailers used as temporary living quarters.

Exemptions to Limitations on Business Interest Deductions

The limitations on the amount of business interest deductions may not apply for certain businesses. Excepted businesses include:

• A business entity that provides services as an employee.
• Certain real estate businesses that choose to be excepted.
• Certain farm businesses that choose to be excepted.
• Certain types of regulated utilities.

A real estate business or farm business that elects to be an excepted business must file a statement along with its tax return for the tax year in which it is making the election. These elections are generally irrevocable, and a status as an excepted business will apply for all future tax years. A real estate business that elects to be excepted will be required to use the alternative depreciation system (ADS) when calculating the depreciation of property used for residential rentals, nonresidential real estate, and qualified improvement property. A farm business that elects to be excepted will be required to use ADS to calculate depreciations for any property with a recovery period of at least 10 years.

Certain small businesses may also be exempt from the limitations on business interest deductions if they meet what is known as a "gross receipts test." As long as it is not treated as a tax shelter, a small business with average annual gross receipts under a certain amount during the previous 3 years will be exempt. This amount is adjusted for inflation each year. For 2026, the amount is $32 million.

Contact Our San Jose, CA Business Tax Lawyer

Changes to business interest deductions have been made in recent years, including by the One Big, Beautiful Bill Act that was passed in 2025. Understanding how the rules may apply to a specific business, including the limits that may apply to deductions and whether a business may be exempt from these limitations, can help ensure that a business will be able to minimize its tax burdens while resolving any disputes with the IRS. At John D. Teter Law Offices, our San Jose business tax attorney can provide guidance on how to address these issues, including representing businesses during tax audits or other interactions with IRS officials. Contact us today at 408-866-1810 to arrange a consultation.