What is this IRC Section 163(j) Note Doing on my K-1?
By: Scot Goldring, Tax Senior Manager, and Kelsey Monaghan, Tax Associate
If you own a portion of a company doing business as a partnership or S corporation, you are eagerly awaiting the arrival of your K-1. This year, you may notice something different – disclosures related to new Section 163(j) limitations.
What is Section 163(j)?
The new 163(j) limitations are a product of PL 115-97, better known as the Tax Cuts and Jobs Act (TCJA). Generally, taxpayers can deduct interest expense paid or accrued in the taxable year. However, if Section 163(j) applies, the amount of deductible business interest expense in a taxable year could be limited. 163(j) applies primarily in these situations:
- Companies with revenues averaging over $25,000,000 per year for the last three years
- When a company is subject to being classified by the IRS as a tax shelter
Any investor in a company that is subject to 163(j) limitations has further reporting requirements on his or her individual tax return.
You may be surprised to see these disclosures on your K-1 because your company does NOT meet the above requirements. In many cases, NONE of the K-1 recipients will be subject to the 163(j) limitation.
So why will many taxpayers still receive this disclosure?
To answer this question, we refer to the IRS guidance. Form 8990 is dedicated to reporting information as it applies to 163(j). Per the instructions to Form 8990:
“If a pass-through entity is not required to file Form 8990 because it is a small business taxpayer, but a partner or shareholder is required to file Form 8990, the pass-through entity may be requested to provide certain information so that the partner or shareholder can complete their return.”
Consider the following example:
- Company A is subject to 163(j) and its partners are Tom, Mary and John.
- Company B is NOT subject to 163(j) and its shareholders are Peter, Mary and Paul.
Uh-oh. Is that the same Mary? If the answer is yes, then Mary is subject to 163(j) and she will need to report information from Company A and Company B on Form 8990 when she files her individual return. If Company B did not provide the necessary disclosures, then Mary’s aggregated reporting would be incorrect.
Neither the issuing company nor CPA firms have any way of knowing what other investments partners may own. Because this is unknown, disclosures should be provided at the entity level. Providing this disclosure on all K-1’s ensures that all investors have the necessary information to correctly report 163(j) limitations on their individual tax returns when necessary.