Business interest deduction 2026 One Big Beautiful Bill

How the One Big Beautiful Bill changes business interest

The One Big Beautiful Bill Act (Public Law 119-21) delivers a long-awaited fix to one of the most restrictive provisions in recent tax law. Under Section 163(j), businesses are limited in how much interest expense they can deduct each year. The deduction is capped at 30% of adjusted taxable income (ATI), and the way that ATI is calculated has enormous practical consequences for capital-intensive businesses.

From 2018 through 2021, ATI was computed using an EBITDA-style formula, meaning earnings before interest, taxes, Depreciation and amortization were added back before applying the 30% limit. Starting in 2022, the law shifted to an EBIT-based formula, removing those add-backs. That change dramatically reduced ATI for businesses with significant fixed assets, slashing the amount of interest they could deduct each year.

The One Big Beautiful Bill Act corrects this under Section 70341. It permanently restores the EBITDA-based ATI formula for taxable years beginning after December 31, 2024. For businesses carrying meaningful debt, this single provision can unlock hundreds of thousands of dollars in previously disallowed interest deductions each year. Manufacturing companies, real estate operators, and pass-through entities financing growth with borrowed capital should understand how the restored rules work before filing their 2026 returns.

How the business interest deduction limit works in 2026

Section 163(j) applies to most businesses and limits their annual business interest deduction to 30% of ATI plus their business interest income. Any interest expense that exceeds this cap is not permanently lost; it is carried forward indefinitely to future tax years.

Under the restored One Big Beautiful Bill rules, ATI is calculated as follows:

1. Start with taxable income before the interest deduction
2. Add back business interest expense
3. Add back net operating loss deductions
4. Add back the 20% qualified business income (QBI) deduction
5. Add back deductions for depreciation and amortization of tangible and intangible property

Step 5 is what was removed in 2022 and what the One Big Beautiful Bill Act permanently restores. Because depreciation and amortization add-backs can amount to millions of dollars for manufacturing, real estate, or equipment-heavy businesses, their inclusion in ATI directly expands the deductible interest for every affected taxpayer.

Consider this illustration. A manufacturing business with $8 million in taxable income, $4 million in annual depreciation and amortization, and $4.5 million in business interest expense shows a clear difference under the two formulas. Under the restored EBITDA method, ATI equals $16.5 million, and the 30% cap is $4.95 million, meaning all $4.5 million in interest is fully deductible. Under the prior EBIT method, ATI is only $12.5 million, and the cap falls to $3.75 million, leaving $750,000 in disallowed interest. At a 21% corporate rate, that difference alone is worth $157,500 per year, and for high-income pass-through owners taxed at 37%, the annual savings reach $277,500.

Which small businesses are exempt from the 163(j) limit

Not every business is subject to the Section 163(j) limitation. The One Big Beautiful Bill Act preserves the existing small business exemption, which excludes businesses whose average annual gross receipts do not exceed $30 million (inflation-adjusted) over the prior three-year period.

Businesses that qualify for this exemption include:

• Sole proprietors, Partnerships, and S Corporations with three-year average gross receipts under $30 million
• C Corporations meeting the same gross receipts threshold
• Tax-exempt organizations with respect to their exempt activities
• Certain regulated utilities under specific IRS rules

If your business qualifies, Section 163(j) does not apply, and you can deduct all business interest expenses in the year it is paid or accrued. Many Individuals who operate smaller businesses or family-owned operations fall comfortably under this threshold and owe no further planning around the limitation.

The three-year average is not based solely on current-year revenue. A business that recently crossed $30 million may still qualify if its prior three-year average is below the threshold. In contrast, a business with declining current-year revenue but a high three-year average remains subject to the cap. This averaging rule creates meaningful planning opportunities for businesses near the threshold. Per IRS Publication 535, general rules for business interest deductibility apply unless a specific limitation overrides them.

How real estate businesses can avoid the 163(j) cap

Real estate trades or businesses occupy a unique position under Section 163(j). A qualifying real estate business may elect out of the limitation entirely. However, electing out comes with a trade-off: the business must use the Alternative Depreciation System (ADS) for certain residential and nonresidential real property, thereby extending recovery periods and reducing annual depreciation deductions.

Under ADS, residential rental property is depreciated over 30 years instead of the standard 27.5 years, and nonresidential property over 40 years instead of 39 years. For a real estate business with substantial depreciable assets, this extension of recovery periods meaningfully reduces annual depreciation deductions. It can offset a significant portion of the interest deduction benefit gained by electing out of 163(j). IRS Publication 946 provides full guidance on depreciation methods, recovery periods, and ADS elections.

The One Big Beautiful Bill Act does not alter this real estate election framework, meaning the election and its trade-offs remain in place for 2026 and beyond. Real estate operators should weigh the following before making or maintaining this election:

1. Properties with long ADS lives will generate smaller annual depreciation deductions
2. Businesses with large interest expense loads may benefit from electing out to avoid the 30% ATI cap
3. Businesses with modest debt relative to income may preserve more value by keeping depreciation intact

For operators also considering the Augusta rule or other property-related strategies, the interaction between the 163(j) election and depreciation recovery should be analyzed before any election is filed or revoked.

How floor plan financing works under the new tax law

The One Big Beautiful Bill Act expands a specific exemption within Section 163(j) that applies to floor plan financing interest. Floor plan financing is the short-term, revolving credit used by dealers to finance inventory. A car dealership borrowing to stock its lot is a common example. Floor plan financing interest is fully deductible and not subject to the 30% ATI cap.

Under Section 70311, the definition of "motor vehicle" for floor plan financing purposes is broadened to include recreational trailers and campers designed for temporary living quarters that are towed by motor vehicles. Previously, this category was limited to more traditional motor vehicles.

This change means RV dealers, camper retailers, and similar businesses can now treat their inventory financing interest as floor plan financing interest, which is fully deductible without restriction. Key details include:

• Floor plan interest is deductible without the 30% ATI restriction
• No carry-forward of disallowed interest applies
• Full deductibility applies to taxable years beginning after December 31, 2024

This expansion reflects the One Big Beautiful Bill Act's broader policy goals of supporting American manufacturing and retail businesses that depend on inventory financing to operate competitively.

Business interest deduction changes for multinationals

For U.S. businesses with controlled foreign corporation (CFC) income, the One Big Beautiful Bill Act makes an additional adjustment to the ATI definition under Section 70303. Effective for taxable years beginning after December 31, 2025, the following income types are excluded from ATI when calculating the Section 163(j) limitation:

• Subpart F income inclusions under Section 951(a)
• Global intangible low-taxed income (GILTI) under Section 951A(a)
• Deemed paid foreign tax credits under Section 78
• Related deductions under Sections 245A(a) and 250(a)(1)(B)

Prior to this change, U.S. shareholders of CFCs were required to include these foreign income items in ATI, which could inflate the ATI base and paradoxically allow more business interest deductions than the legislation intended for domestic income purposes. The Section 70303 correction isolates the 30% cap to domestic income.

Multinational businesses operating as C Corporations or Partnerships with CFC structures should model the impact of this change on their deductible interest going into 2026, as it takes effect one year after the EBITDA restoration.

How to calculate your interest deduction savings in 2026

Your potential tax savings under the restored rules depend on your total interest expense, depreciation and amortization, and your entity structure. The pass-through example below illustrates how dramatically EBITDA restoration can affect high-D&A businesses.

Pass-through entity example:

• Taxable income before interest deduction: $5 million
• Annual depreciation and amortization: $6 million
• Business interest expense: $4.5 million
• EBITDA-based ATI: $15.5 million → 30% cap = $4.65 million → $0 disallowed
• EBIT-based ATI: $9.5 million → 30% cap = $2.85 million → $1.65 million disallowed
• Annual tax savings at 37%: $610,500

Strategic considerations for maximizing savings include:

1. Project your ATI under the EBITDA formula before year-end to confirm your full interest load is deductible
2. Time major depreciation and amortization events to expand ATI in years when interest expense is highest
3. Evaluate whether your entity structure (pass-through vs. C Corporation) optimizes the benefit from the restored deduction
4. Coordinate with a tax professional to account for any state-level conformity differences before filing

Coordinating interest deductions with 2026 tax strategies

The restored business interest deduction rules interact productively with several other provisions of the One Big Beautiful Bill Act and broader 2026 tax planning strategies.

Bonus depreciation coordination: The One Big Beautiful Bill Act extends 100% bonus depreciation through December 31, 2029. Larger upfront depreciation deductions increase ATI under the EBITDA formula, thereby increasing the 30% interest deduction ceiling. Businesses that aggressively claim bonus depreciation will simultaneously expand their Section 163(j) limit.

R&D expensing: The One Big Beautiful Bill Act restores immediate expensing of domestic research and development costs. Businesses relying heavily on AI-driven R&D tax credits should model how R&D spending affects both their taxable income and ATI calculation, as the two interact with offsetting effects on the Section 163(j) limit.

Retirement plan contributions: Business owners using Traditional 401k plans to reduce taxable income should account for how lower taxable income affects the ATI calculation. In some cases, maximizing retirement contributions could reduce ATI and inadvertently tighten the interest deduction limit. See IRS Publication 560 for guidance on retirement plan deductions for small businesses.

Health reimbursement arrangements: Businesses that offer employees a Health reimbursement arrangement generate additional deductible expenses that reduce taxable income. Running a coordinated projection across all applicable provisions is the most reliable way to confirm whether the 30% cap constrains interest deductibility in any given year.

How to recover disallowed interest from prior tax years

Disallowed business interest expense does not expire. Under Section 163(j), any interest that cannot be deducted in the current year because of the ATI cap is carried forward to future taxable years indefinitely. In those future years, the carryforward is treated as additional business interest expense subject to the same 30% ATI limit.

With the EBITDA restoration now permanent, many businesses that accumulated disallowed interest carryforwards during the 2022 through 2024 EBIT period will find that those carryforwards are now more easily absorbed. Higher ATI under the EBITDA formula creates room for both current-year interest expense and prior-year carryforwards. The practical result is that some businesses may see three years' worth of pent-up carry-forward interest become deductible starting in 2026, producing a one-time catch-up benefit on top of the ongoing annual savings from the restored formula.

Multi-year planning steps for businesses with interest carryforwards include:

1. Calculate the current ATI under the restored EBITDA formula to determine available deduction space
2. Determine the total accumulated carry-forward balance from prior restricted years
3. Project whether the current-year business interest plus carryforwards can be fully absorbed in 2026
4. Plan major depreciation or income events to expand ATI if carryforwards remain
5. Coordinate carry-forward absorption with any Late S Corporation elections or entity restructuring plans

State conformity is also relevant. Many states conform to federal 163(j) rules, but some maintain separate limitations. Businesses operating in high-tax states should check the 2026 California State Tax Deadlines and their state's specific conformity rules before projecting total combined savings.

Start maximizing your business interest deductions in 2026

The One Big Beautiful Bill Act's permanent restoration of EBITDA-based ATI is one of the most significant structural improvements for businesses carrying debt. Whether you operate a manufacturing company, a real estate portfolio, or a pass-through entity with significant fixed assets, the restored rules expand your deductible interest and reduce disallowed expense carryforwards.

Instead makes it straightforward to model your Section 163(j) position under the EBITDA rules, track carryforward balances, and coordinate the business interest deduction with bonus depreciation, R&D expensing, and other One Big Beautiful Bill provisions. Instead's intelligent system analyzes your full business profile to identify every available deduction and flag coordination opportunities that manual planning can miss.

Explore Instead's pricing plans to see how the platform can help you maximize the restored business interest deduction and build a comprehensive 2026 tax strategy.

Frequently asked questions

Q: What does the One Big Beautiful Bill Act change about business interest?

A: The One Big Beautiful Bill Act permanently restores the EBITDA-based formula for calculating adjusted taxable income under Section 163(j), effective for taxable years beginning after December 31, 2024. Depreciation and amortization are added back when computing ATI, increasing the 30% deductible interest ceiling for capital-intensive businesses.

Q: Is my small business exempt from the interest deduction limit?

A: Yes, if your business averages $30 million or less in gross receipts over the prior three tax years (with the threshold indexed for inflation), you are exempt from the Section 163(j) limitation entirely. You may deduct all business interest expenses without restriction under IRS rules.

Q: What happens to the disallowed business interest expense I carry from prior years?

A: Disallowed interest expense carries forward indefinitely as business interest expense in future years, subject to the same 30% ATI cap. With the EBITDA restoration permanent, businesses that accumulated carryforwards during 2022 through 2024 will generally find more room to absorb them starting in 2026, and should plan a year-end projection to confirm how much is absorbed.

Q: Can real estate businesses elect out of the interest deduction limit?

A: Real estate businesses can elect out of Section 163(j) to deduct unlimited interest expense, but must use ADS depreciation for certain property. The One Big Beautiful Bill Act does not change this election framework. Operators should model whether the ADS depreciation trade-off is worthwhile given their specific debt and depreciation profile.

Q: How does the One Big Beautiful Bill affect interest deductions for businesses with foreign subsidiaries?

A: The Section 70303 changes that exclude Subpart F income, GILTI, and deemed-paid foreign tax credits from ATI apply to taxable years beginning after December 31, 2025, one year after the EBITDA restoration under Section 70341.

Q: Can I combine the business interest deduction with bonus depreciation?

A: Yes. Under the EBITDA formula, depreciation and amortization add-backs raise ATI, which lifts the 30% interest deduction ceiling. Businesses that claim 100% bonus depreciation under the One Big Beautiful Bill Act simultaneously expand their deductible business interest limit, creating compounding annual tax benefits. The two provisions are designed to work together, and businesses that use both should model their combined ATI impact before year-end to confirm that no interest expense remains disallowed.