Higher Interest Deductions Allowed for Remainder of 2020

The U.S. Internal Revenue Service (IRS) moved on Tuesday to ease the tax burdens of private equity portfolio companies and heavily indebted industries.

Prior to President Donald Trump’s 2017 tax-code overhaul, interest expenses were generally fully deductible. The Trump tax law capped tax deductions for debt interest payments at 30 percent of EBITDA (earnings before interest, taxes, depreciation, and amortization).

The new arrangement, laid out in 575 pages, reflects a temporary bump in the cap, to 50 percent through year-end. In addition, the Treasury will no longer apply a limit on some transactions that don’t officially take the form of a loan, but that potentially could be used to skirt the deduction cap. Included in that classification are debt-issuance costs, commitment fees, and some hedging gains and losses.

Tuesday’s move aside, a looming hit to high-debt businesses remains in place. The 2017 law included a provision for limiting corporate tax breaks starting in 2022. That change will have depreciation and amortization—deductions based on the value of a business’s property—no longer included in the earnings total that’s the basis of how much a company can write off.

Enacting that step will shrink the amount of interest that a company can deduct, though leftover interest expenses could be carried over as a tax break in subsequent years.

The National Association of Manufacturers (NAM), a lobbying giant that had already pushed lawmakers to put a stop to the 2022 move before Covid-19 struck, is now framing the demand as far more urgent. “Without revenues coming in while you’re still operating, debt financing becomes more and more critical,” said Chris Netram, vice president of tax and domestic economic policy at NAM.

Netram said his group wants the upcoming fiscal-stimulus bill to include a provision that eliminates the tightening of the limit. Earlier this year, NAM released policy objectives for the long-term post-pandemic recovery that included legislation to prevent the 2022 change.

The private-equity world also had its eyes on this issue well before the pandemic struck. Corporate takeovers by such firms tend to load the targets up with debt as part of the deal. If debt premiums surge, that could leave those businesses in trouble.

While the Federal Reserve’s policy rate may currently be at rock bottom, corporate borrowers will still face relatively high borrowing costs because the crisis makes them riskier investments, said Vipul Amin, a managing director of Carlyle Group, who called the planned interest-limit change “salt in the wound” created by the pandemic crisis.

“If you have any risk associated with you, there’s a bigger premium than there was before,” Amin said. He said his anticipation of a “death spiral” of low earnings and higher after-tax debt financing costs in face of recession was now coming to fruition.

The impending 2022 change hardly damped interest in selling debt before Covid-19. The ratio of publicly traded, nonfinancial companies’ debt to assets hit the highest level in two decades at the start of this year, according to a Fed report in May. For the most highly leveraged firms, the Fed found, the ratio of debt to assets was “close to a record high.”

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