February 13, 2019
Mr. Zachary King and Ms. Meghan Howard
IRS Office of the Associate Chief Counsel
Internal Revenue Service
Courier's Desk, Internal Revenue Service
1111 Constitution Avenue NW
Washington, DC 20224
Dear Mr. King and Ms. Howard:
Baker Tilly Virchow Krause, LLP, on behalf of our clients, offers the following comments concerning the proposed regulations under Internal Revenue Code (“Code”) section 163(j). We recognize the enormity of the task of designing regulations across both pass-through and taxable entities, coupled with the interaction with the aggregation rules that were not designed with section 163(j) in mind.
Our comments are in the areas of (1) aggregation rules under proposed section 1.163-(j) and (2) interest capitalized under other sections of the Code.
Small Business Exception and Aggregation Rules
Proposed section 1.163(j)-6(m) provides guidance regarding partnerships and S corporations not subject to section 163(j) by reason of the small business exemption. If a partnership or S corporation is not subject to section 163(j) by reason of proposed section 1.163(j)-2(d) ($25 million gross receipts test), the exempt entity is not required to perform the business interest expense limitation calculations under proposed sections 1.163(j)-2(b) and 1.163(j)-6. However, to the extent a partner or shareholder is allocated business interest expense from an exempt entity, that business interest expense will be subject to the partner or shareholder’s own section163(j) limitation. Individual partners and shareholders are then required to apply the gross receipts test to determine whether they are subject to the section 163(j) limitation at the individual level.
Proposed section 1.163(j)-2(d)(2)(iii) provides that each partner in a partnership includes a share of partnership gross receipts in proportion to such partner’s distributive share of items of gross income that were taken into account by the partnership under section 703. With respect to shareholders in S corporations, these regulations would provide that such shareholders include a pro rata share of the S corporation’s gross receipts.
While section 163(j)(3) would apply the rules of section 448(c), we believe to apply those rules without modification is prejudicial against affected taxpayers. Specifically, the rules of section 448(c) were enacted to govern the use of the cash method of accounting. Those rules were not designed with section 163(j) in mind and, in fact, were enacted well before section 163(j) came into existence. Therefore, we believe that using the 448(c) rules, without modification, is not appropriate for determining gross receipts for section163(j) purposes.
For purposes of an individual computing his or her gross receipts for section 163(j) purposes, we respectfully recommend that the individual should only include gross receipts from entities exempt under the section 163(j) small business exemption. Accordingly, the following would be specifically excluded from an individual’s gross receipts computation:
- Electing real property trade or business entities
- Entities utilizing the floor plan interest exception under section 163(j)(1)(C)
- Entities already subject to section 163(j)
Gross receipts from partnerships or S corporations qualifying for the small business exception would continue to be included in the respective partner or shareholder’s share of gross receipts. This modification would both simplify the computation of gross receipts for the individual taxpayer as well as prevent those gross receipts from being double counted in consideration of the $25 million threshold. Further, we note entities described in items 1 and 2 above are provided specific exclusions from the section 163(j) rules, and to include gross receipts therefrom in an owner’s $25 million computation would negate congressional intent in enacting those exclusions.
Interest Capitalized Under Other Sections of the Code
The preamble to the regulations includes the following language (emphasis on the italicized section):
Proposed section 1.163(j)-1(b)(1) includes as adjustments to taxable income items specifically referenced in section 163(j)(8)(A): Any item of income, gain, deduction, or loss which is not properly allocable to a trade or business; business interest and business interest income; net operating loss deductions under section 172; deductions for qualified business income under section 199A; and deductions for depreciation, amortization, and depletion, but only with respect to taxable years beginning before January 1, 2022. Net operating losses under section 172 are added to taxable income in determining ATI, including net operating losses arising in taxable years prior to the effective date of these proposed regulations and carried forward. For purposes of computing ATI, it is intended that deductions for depreciation include special allowances under section 168(k). Additionally, to clarify an issue raised by a commenter in response to Notice 2018-28, the Treasury Department and the IRS note that an amount incurred as depreciation, amortization, or depletion, but capitalized to inventory under section 263A and included in cost of goods sold, is not a deduction for depreciation, amortization, or depletion for purposes of section 163(j).
Section 163(j)(8)(A)(v) specifically excludes depreciation from the computation of ATI for taxable years beginning before Jan. 1, 2022. Proposed section 1.163(j)-1(b)(1)(i)(D) and section 1.163(j)-1(b)(1)(i)(E) provide for additions to taxable income for certain items of depreciation and amortization. Proposed section 1.163(j)-1(b)(1)(iii) provides that depreciation, amortization or depletion expense that is capitalized to inventory under section 263A is not a depreciation, amortization or depletion deduction. These deduction items that are capitalized under section 263A are not additions to taxable income. We do not object to lack of an add-back for depreciation that is capitalized and included in inventory on hand at the end of the year. Such an exclusion is fair and makes sound policy sense. However, to exclude an add-back for capitalized depreciation that is included in the current-year’s cost of goods sold is prejudicial against affected taxpayers and makes them forgo a benefit designed around bonus depreciation that is afforded to other taxpayers.
The exclusion of such an add-back is particularly detrimental to the manufacturing industry. For manufacturers, almost everything they purchase fits the definition of inventory or cost of goods sold, so the elimination of the exclusion for depreciation coming in 2022 has effectively already occurred for this sector. Given that numerous changes in the Tax Cuts and Jobs Act were included in order to help the U.S. manufacturing industry, we view such a rule as counterproductive to congressional intent and the health of the U.S. manufacturing industry. Accordingly, we respectfully recommend that taxpayers be allowed to add back depreciation and amortization that is included in cost of goods sold for years through 2021.
We appreciate your time and consideration. If you would like to discuss or have any questions, please do not hesitate to contact me at my direct dial below.
Baker Tilly Virchow Krause, LLP trading as Baker Tilly is a member of the global network of Baker Tilly International Ltd., the members of which are separate and independent legal entities.
Very truly yours,
BAKER TILLY VIRCHOW KRAUSE, LLP
Director, National Tax
Direct dial 703 923 8489
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