Forget Debt? Maybe Not Yet: How to Grow without Full Business Interest Deduction
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Manufacturers and other companies that traditionally rely on debt as a growth strategy need to consider new approaches, now that the business interest deduction has been slashed.
Before recent tax reform, the business interest deduction was 100 percent. Now it’s just 30 percent of a company’s adjusted taxable income, which is computed in a way similar to EBITDA.
Small businesses, those under $25 million in gross receipts, are exempt. All others must explore their options against the higher costs of borrowing.
Among various industries, manufacturing has been more widely leveraged than some. Now, with capital spending up because of constant innovation, many manufacturers have increased their R&D and are even planning “moonshot” goals, according to the 2017 Duke University/CFO Global Business Outlook.
But before you look skyward, make some key calculations.
Some Debt Still Makes Sense
Manufacturers and other companies have valid reasons to maintain debt, such as ownership structure or available capital. And now, even after tax reform, debt will still make sense in many cases. So, don’t automatically eliminate growth that requires new debt.
But understand that now, more than ever, growth strategies that involve taking on new debt may lead to interest payments that are not currently deductible. This can lead to an increase in a company’s overall tax liability and less cash flow to fund operations.
As your adjustable taxable income climbs, so does your allowable business interest deduction.
Ways to Soften the Blow
The new tax code contains many other changes that may help mitigate the impact of new business interest deduction rules.
- Those start with the overall reduction of the corporate tax rate to 21 percent from the previous level of 35 percent, and the rate reduction on income from flow-through entities from 39.6 percent to a net 29.6 percent after applying the qualified business income deduction.
- More generous depreciation rules mean you can write off 100 percent of costs associated with qualifying capital purchases (in the year the assets are placed into service).
- New tax laws also allow companies to carry forward any interest that exceeds the 30 percent cap. It’s eligible for a tax deduction in the following year, subject to the same limitations. This can be helpful in reducing tax liability in future years, especially when you are not introducing new debt to the balance sheet.
Business Interest Deduction: Is New Debt Negative?
If your company is highly leveraged, business interest deduction limits will require you to evaluate the implications for your overall tax liability. Revenue forecasts and tax projection scenarios will lead you to smart decisions that will preserve healthy cash flow.
It’s more important than ever to be smart about your debt load and understand the impact on tax liability and potential cash flow.
Based on the amount of debt your company has, will new debt have a negative impact?
You might need to contact a CPA-led business advisory firm for help making these decisions.