Today, the S Corporation Association submitted its formal comments to the IRS on the pending Section 163(j) rules. Section 163(j) would impose the new, 30 percent cap on interest deductions as part of the Tax Cuts and Jobs Act (TCJA).
Under the TCJA, Congress intended to impose a higher cap to start, and then lower the cap in the future, giving affected companies time to prepare for the new policy. But the rules proposed by the IRS would inexplicably apply the lower, more onerous cap to manufacturers immediately! This is definitely not what Congress intended and will come as an unwelcome surprise to Main Street manufacturers across the country.
The basic message of S-Corp’s submission was that Treasury should apply the same rules to manufacturers as other industries. As the comments conclude:
Generally speaking, then, the new cap on interest deductibility is 30 percent of a taxpayer’s taxable income before interest, tax, depreciation and amortization (EBITDA) in tax years 2018 through 2021, and 30 percent of a taxpayer’s taxable income before interest and tax (EBIT) in tax years 2022 and beyond.
The proposed rules, however, do not follow this general approach in the case of manufacturers. This is because the rules effectively prevent taxpayers from adding back depreciation that is capitalized under Section 263A into inventory and recovered through cost of goods sold. Since manufacturers are required to capitalize to inventory their depreciation relating to investments in equipment and facilities, the rules block this depreciation from being added back to taxable income when determining ATI.
As a result, while other businesses will be subject to a cap on interest deductions equal to 30 percent of EBITDA through tax year 2021, manufacturers will be subject to a more onerous cap equal to 30 percent of EBIT beginning immediately.
Unchanged, this result is guaranteed to blindside many manufacturing businesses when they file their taxes this year. S-Corp has a number of members who are unaffected by a cap based on EBITDA but will pay significantly higher taxes under a cap based on EBIT. This is clearly not the result Congress intended when it adopted the TCJA.
In submitting these comments, S-Corp joined the U.S. Chamber of Commerce and other advocates in raising concerns about the rule’s impact on the manufacturing sector. As the Chamber notes:
Prop. Regs. §1.163(j)-1(b)(1)(iii) should be stricken as it adversely impacts certain business sectors, contrary to Congressional intent. The House and Senate bills differed on whether depreciation, amortization and depletion should be disregarded in computing ATI. The 2022 effective date to reduce ATI for such items was a compromise in conference committee. The impact of this regulation is to accelerate the negative impact selectively to manufacturers in 2018.
Four out of five manufacturing businesses are organized as pass-throughs. These businesses are counting on the new expensing and other friendly provisions included in the TCJA in crafting their business plans for 2018 and beyond. The proposed 163(j) rules would effectively eliminate the benefit of expensing for many of these businesses and subject them to effective marginal tax rates that far exceed anything else in the Tax Code. This issue is important to employers and communities throughout the country. S-Corp intends to follow up on its comments and meet with Treasury officials to push for these changes.