Why is there an IRC Section 163(j) note on my K-1?
By: Scot Goldring, Tax Senior Manager, and Kelsey Monaghan, Tax Associate
If you own part of a company doing business as a partnership or S corporation, you’re 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 Section 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.
When does Section 163(j) apply?
Section 163(j) applies primarily in these situations:
- Company revenue more than $25 million per year on average for the last three years
- Company subject to being classified by the IRS as a tax shelter
Any investor in a company that is subject to Section 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 Section 163(j) limitation.
Why would taxpayers receive a Section 163(j) disclosure on their K-1?
To answer this question, we refer to the IRS guidance. Form 8990 is dedicated to reporting information as it applies to Section 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 Section 163(j) and its partners are Tom, Mary and John.
- Company B is NOT subject to Section 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 Section 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 like ours have any way of knowing what other investments partners may own.
Because this information is unknown, disclosures should be provided at the entity level.
Providing this disclosure on all K-1s ensures that all investors have the necessary information to correctly report Section 163(j) limitations on their individual tax returns when necessary.
For clarification or if you have further questions on your Section 163(j) limitations and reporting requirements, contact Scot Goldring.