Private Equity Firms Get Clarity on Interest Deduction Limits
Companies that are highly leveraged can start calculating how much the Republican tax law limits their interest deductions for debt. This knowledge came about due to 439 pages of regulations released by the IRS on November 26, 2018.
The proposed rules in this release provide guidance related to a key provision in the 2017 tax overhaul that places restrictions on deductions businesses can take from the interest they pay on loans. In past years, those interest expenses were completely deductible. The IRS stated that these new limits apply to interest paid on traditional loans and other debt instruments that are not officially loans but have the same purpose and substance.
The regulations also strive to block certain creative financing transactions businesses may employ to avoid deduction caps.
Private equity deals that could involve large amounts of debt are particularly susceptible to the interest deduction change and how the IRS implements that change. This change will not be as critical to public corporations as they tend to be less leveraged.
The restriction on the interest deductions is an attempt by Congress to level the treatment of debt and equity financing. The measure was also included to offset tax cuts such as the reduction of the corporate tax rate from 35 percent to 21 percent.
The law allows companies to deduct costs up to 30 percent of EBITDA (earnings before interest, tax, depreciation, and amortization) until 2022. Following 2022, the cap narrows to 30 percent of EBIT (earnings before interest and taxes). EBIT includes depreciation and amortization which make it lower than EBITDA and will make more companies subject to the limitation.