 Hello and welcome to this session in which we will discuss the business interest expense limitation. What is the big idea of this business interest expense limitation is to limit the deduction of interest expense for C corporation. So the first thing we need to know is this limitation applies only to C corporation. And what's the purpose of it? The purpose of it is to curb the deduction of interest expense. Why? Interest expense is a form of financing. That's fine. You borrow money, you pay interest on it. Nothing wrong with this. Except interest expense is tax deductible. So what the government is saying, that's a great, you can deduct it. But we want to limit that deduction since you are financing yourself so you don't go crazy and finance yourself with that and get a tax deduction. So the Tax Cuts and Jobs Act of 2017 introduced this limitation on interest expense deduction, whether that interest expense is paid or accrued. And this restriction, as I just mentioned, applies to C corporation. So what is the deduction limited to? So how much would they limit to? They limit you to the sum of those following. Well, taxpayer business income, they limit you to that plus sum plus the sum. So that amount plus 30% of the taxpayer adjusted taxable income, which we're going to see what adjusted taxable income is in a moment, plus the taxpayer floor planning financing interest for the year. What is the floor planning financing interest? It's how much it's costing you to finance your inventory. A good example will be auto dealers. Auto dealers, the majority of auto dealers. When you see those cars in a parking lot at auto dealers, well, the dealer paid for this. Yes, but they usually borrow money to do that. That's a lot of money. No one will have millions and millions of dollars sitting in the bank. And they have to pay interest on that. Well, the majority of auto dealers obtained their inventory through that commonly referred to as the floor plan, floor plan financing, which is secured by the inventory itself, because whoever gives you the money, usually the bank, they look at the cars as collateral. Well, interest on this type of that floor planning is fully deductible without any limitation because you are trying to obtain inventory. Now the risk is the risk in this business interest expense is when you try to finance yourself through that. That's what they're trying to avoid. Finance your company through that. But if you're financing your inventory, that's part of your business. That's fine. Now, how do we compute adjusted taxable income? Before we proceed any further, I have a public announcement about my company, farhatlectures.com. Farhat accounting lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions, as well as exercises. Go ahead, start your free trial today. Well, adjusted taxable income is taxable income computed before you take into account any non-business income. So you don't take into account any non-business income gains deduction. So non-business, it means non-business. It's not business related. Any business interest in business income. So you don't take into account the interest because the whole thing is about the interest deduction. You don't take into account NOL because net operating loss deduction is usually coming from the prior year. You don't include this. You don't include any qualified business income deduction, which is usually doesn't apply for C corporation, just only agricultural and horticultural, which is not really relevant. And any deduction allowed for depreciation, amortization, and depletion. I'm sure you learned in your financial accounting course earning before interest and taxes, this EBIT, okay. Sometimes they call it earning before depreciation, EBIT earning before depreciation, interest, and taxes. Simply put, this adjusted taxable income is earning before any type of interest income or interest expense. So you have to take out both expense and income. Any depreciation, amortization, or depletion, any NOL, any non-business activity. So simply put, they're focusing on your taxable income from the business for that particular year without taking into account interest and depreciation. What happened if you have unused interest expense? So you are limited. You are limited to a certain amount. So what happened to that amount that you cannot take? Well, any disallowed amount can be carried forward and utilized in future tax year. However, this limitation don't apply to small businesses. So small business exception, if you're considered a small business, and let's consider the small business for our purpose, well, if the taxpayer average gross receipts for the prior three years is a certain number. For 2023, it's 29 million. For future years, it will be much higher. So just as long as you are a small business exception, I happen to give you the number here because just for illustration, this number could be different in future years. So if you qualify for the small business exception, you don't have to worry about this limitation. In other words, you can take all of your interest expense. Let's take a look at a couple examples to see how this works. In 2023, Adam, a C corporation with a calendar year report 2.1 million of adjusted taxable income. Adam earns 80,000 of interest income. This is interest income. They have some sort of an investment and they earn interest income and incurred 1 million in interest expense. That's the expense. They don't have any floor planning. How much can Adam take in interest expense? Well, what's the formula? The formula is you are limited to interest income, which happens to be 80 percent, the sum of your interest income, plus 30 percent of your adjusted taxable income. We're going to, 30 percent is 2.1 million times 30 percent. We're going to assume that this is the proper adjusted taxable income, not including whatever we talked about in the prior session. Therefore, if we total those, you are limited to 710,000. However, you paid a million dollars. Well, if that's the case, you have an excess of 290,000. It cannot be deducted this year, but it cannot be deducted in future years. Carry forward and treat it as a business interest expense in future years. Now, bear in mind, if Adam was considered a small business, that amount is fully deductible and that amount is 1 million will be fully deductible. Let's assume Adam's adjustable taxable income was 5 rather than 2.1 million. Well, if that's the case, the full amount is deductible. Why? Because if you take 5 million times 30 percent, that's going to give you 1.5 million. Well, 1.5 million is greater than the interest expense. Well, that's good because now you have more income. Your interest expense is lesser than 30 percent of your income. That's fine. You're making enough money. We would allow you to deduct that interest expense. Let's take a look at an example where we have a negative adjusted taxable income, which is basically operating at a loss. Assume NOAA, a C corporation, adjusts the taxable income a loss of, this is a loss of 2 million. NOAA earns $50,000 in interest income, no floor planning, and incurred 200,000 in interest expense. What is NOAA's interest expense deduction limited to? Well, you're going to be limited to under those circumstances to your interest income, which is 50,000. You cannot take the loss of 2 million and multiply it by 30 percent. It's a loss. That's fine. You can do that. So you're limited to that. And the remaining, which is 150,000, will be carried to future years when you have earnings and you can deduct this. Let's assume NOAA qualifies as a small business. If that's the case, go ahead, go for it, but full 200,000 is deductible. So in this session, we looked at the limitation for the business interest expense deduction. What should you do now? Go to Farhat Lectures, look at additional resources, MCQs, true, false lectures that's going to help you understand this concept better. Study hard, good luck, and of course, stay safe.