# Bulletin No. 2020–40

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HIGHLIGHTS
OF THIS ISSUE




Bulletin No. 2020–40
September 28, 2020

These synopses are intended only as aids to the reader in
identifying the subject matter covered. They may not be
relied upon as authoritative interpretations.

ADMINISTRATIVE

INCOME TAX

Notice 2020-66, page 785.

Notice 2020-59, page 782.

This notice provides interim guidance addressing whether
certain Medicaid coverage of COVID-19 testing and diagnostic services is minimum essential coverage for purposes of
the premium tax credit under section 36B of the Internal Revenue Code. This notice also announces that the Department
of the Treasury and the Internal Revenue Service intend to
amend § 1.5000A-2 of the Income Tax Regulations to add
Medicaid coverage of COVID-19 testing and diagnostic services to the list of health care coverage that is not minimum
essential coverage under a government-sponsored program.

ADMINISTRATIVE, EMPLOYEE PLANS
Announcement 2020-17, page 794.

Announcement 2020-17 postpones, until January 15, 2021,
the due dates for reporting and paying the excise taxes under §§ 4971(a)(1) and 4971(f)(1) of the Internal Revenue
Code with respect to certain delayed minimum required contributions to a single employer defined benefit plan. This
postponement applies with respect to a required contribution
to which the extended due date under § 3608(a) of the Coronavirus Aid, Relief, and Economic Security Act, Pub. L. No.
116-136 (134 Stat. 281) (CARES Act), applies.

EMPLOYEE PLANS
Notice 2020-72, page 789.

This notice sets forth updates on the corporate bond monthly yield curve, the corresponding spot segment rates for
September 2020 used under § 417(e)(3)(D), the 24-month
average segment rates applicable for September 2020, and
the 30-year Treasury rates, as reflected by the application of
§ 430(h)(2)(C)(iv).

Finding Lists begin on page ii.

This notice contains a proposed revenue procedure with a
safe harbor for a trade or business that manages or operates a qualified residential living facility to be treated as a real
property trade or business solely for purposes of qualifying
as an electing real property trade or business under section
163(j)(7)(B) of the Internal Revenue Code.

Notice 2020-71, page 786.

Optional special per diem rates. This notice provides the
2020-2021 special per diem rates for taxpayers to use in
substantiating the amount of ordinary and necessary business expenses incurred while traveling away from home.
The notice includes (1) the special transportation industry
rate, (2) the rate for the incidental expenses only deduction,
and (3) the rates and list of high-cost localities for the highlow substantiation method.

REG-107911-18, page 795.

This notice of proposed rulemaking supplements TD 9905
and provides rules concerning the limitation on the deduction
for business interest expense. Specifically, these proposed
regulations address application of the limitation in contexts
involving passthrough entities, regulated investment companies (RICs), United States shareholders of controlled foreign
corporations, and foreign persons with effectively connected
income in the United States. These proposed regulations also
provide guidance regarding the definitions of real property development, real property redevelopment, and a syndicate.

Rev. Proc. 2020-41, page 793.

Revenue Procedure 2020-41 provides domestic asset/liability percentages and domestic investment yields needed by
foreign life insurance companies and foreign property and
liability insurance companies to compute their minimum ef-

fectively connected net investment income under section
842(b) of the Internal Revenue Code for taxable years beginning after December 31, 2018.

Rev. Rul. 2020-19, page 611.

This revenue ruling provides guidance on what constitutes a
change in basis of computing life insurance reserves under
§ 807(f) of the Internal Revenue Code, as amended by the
Tax Cuts and Jobs Act. This revenue ruling provides specific
holdings in a number of different situations, with each holding indicating whether the described situation is a change in
basis under § 807(f).

T.D. 9905, page 614.
This document contains final regulations providing
guidance about the limitation on the deduction for
business interest expense. The regulations provide
guidance to taxpayers on how to calculate the limitation, what constitutes interest for purposes of the limitation, which taxpayers and trades or businesses are
subject to the limitation, and how the limitation applies
in consolidated group, partnership, international, and
other contexts.

The IRS Mission
Provide America’s taxpayers top-quality service by helping
them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.

Introduction
The Internal Revenue Bulletin is the authoritative instrument
of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service
and for publishing Treasury Decisions, Executive Orders, Tax
Conventions, legislation, court decisions, and other items of
general interest. It is published weekly.
It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application
of the tax laws, including all rulings that supersede, revoke,
modify, or amend any of those previously published in the
Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements of
internal practices and procedures that affect the rights and
duties of taxpayers are published.
Revenue rulings represent the conclusions of the Service
on the application of the law to the pivotal facts stated in
the revenue ruling. In those based on positions taken in rulings to taxpayers or technical advice to Service field offices,
identifying details and information of a confidential nature are
deleted to prevent unwarranted invasions of privacy and to
comply with statutory requirements.
Rulings and procedures reported in the Bulletin do not have the
force and effect of Treasury Department Regulations, but they
may be used as precedents. Unpublished rulings will not be
relied on, used, or cited as precedents by Service personnel in
the disposition of other cases. In applying published rulings and
procedures, the effect of subsequent legislation, regulations,
court decisions, rulings, and procedures must be considered,
and Service personnel and others concerned are cautioned

against reaching the same conclusions in other cases unless
the facts and circumstances are substantially the same.
The Bulletin is divided into four parts as follows:
Part I.—1986 Code.
This part includes rulings and decisions based on provisions
of the Internal Revenue Code of 1986.
Part II.—Treaties and Tax Legislation.
This part is divided into two subparts as follows: Subpart A,
Tax Conventions and Other Related Items, and Subpart B,
Legislation and Related Committee Reports.
Part III.—Administrative, Procedural, and Miscellaneous.
To the extent practicable, pertinent cross references to these
subjects are contained in the other Parts and Subparts. Also
included in this part are Bank Secrecy Act Administrative
Rulings. Bank Secrecy Act Administrative Rulings are issued
by the Department of the Treasury’s Office of the Assistant
Secretary (Enforcement).
Part IV.—Items of General Interest.
This part includes notices of proposed rulemakings, disbarment and suspension lists, and announcements.
The last Bulletin for each month includes a cumulative index
for the matters published during the preceding months. These
monthly indexes are cumulated on a semiannual basis, and are
published in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

September 28, 2020 

Bulletin No. 2020–40

Part I
Section 807.—Rules for
certain reserves
Rev. Rul. 2020-19
ISSUE
In the situations described below, is
there a change in basis of computing life
insurance reserves under § 807(f) of the
Internal Revenue Code, as amended by
section 13513 of Public Law No. 115-97,
commonly referred to as the Tax Cuts and
Jobs Act (TCJA), 131 Stat. 2054, 2143
(2017)?
FACTS
IC, a calendar year life insurance company within the meaning of § 816(a), issues life insurance and annuity contracts
directly and also reinsures the risks on
such contracts issued by other companies. IC is required to determine life insurance reserves under § 807(d) with
respect to both directly written and reinsured contracts and to take net increases
or decreases in the reserves into account
in computing life insurance company taxable income. IC computes the amount of
the life insurance reserve for a contract in
accordance with the net surrender value
(NSV) floor of § 807(d)(1)(A) and (B) and
the statutory cap of § 807(d)(1)(C).
Situation 1. Beginning in Year 1, IC
issues variable annuity contracts within
the meaning of § 817(d). On its Federal
income tax returns for Years 1 and 2, IC
computed the amount of the reserve with
regard to each of those contracts under the
Commissioners’ Annuities Reserve Valuation Method (CARVM) prescribed by the
National Association of Insurance Commissioners (NAIC) but incorrectly applied
the 92.81% factor of § 807(d)(1)(B) to
that entire amount, rather than only to the
excess of that amount over the greater of
each contract’s NSV or the portion of the
reserve separately accounted for under
§ 817.
Situation 2. In Year 4, the NAIC makes
a change to the NAIC Valuation Manual
21 (VM-21) that imposes a new compu-

Bulletin No. 2020–40

tational requirement as a component of
CARVM on issuers of variable annuities
with guaranteed minimum benefits. The
requirement applies to the determination
of statutory reserves as of December 31,
Year 4, with regard to contracts issued after December 31, Year 1. On its Federal
income tax returns for Years 2 and 3, IC
determined its reserves for variable annuity contracts under the requirements of
VM-21. As a result of the change in VM21, IC’s statutory reserves for these contracts as of December 31, Year 4, will be
lower than they would have been had the
change not been made.
Situation 3. The facts are the same as
in Situation 2, except that the change to
VM‑21 applies to the determination of
statutory reserves as of December 31,
Year 4, with regard to contracts issued after December 31, Year 3.
Situation 4. The NAIC issues a new
Actuarial Guideline that imposes a new
computational requirement for the Commissioners’ Reserve Valuation Method
(CRVM) for universal life contracts issued
before Year 1. The requirement applies to
the determination of statutory reserves for
these contracts as of December 31, Year 3.
IC’s statutory reserves for these contracts
as of December 31, Year 3, will be lower
than they would have been had the NAIC
not issued the new Actuarial Guideline.
Situation 5. IC computes its reserves
for a group of life insurance contracts under NAIC Valuation Manual 20 (VM-20).
The group of contracts passes both the
stochastic exclusion test and the deterministic exclusion test of VM-20, and the
company elects to exclude the group from
both the stochastic reserve calculation
and the deterministic reserve calculation.
Accordingly, the statutory reserve for the
group is equal to the sum of the policy net
premium reserves.
VM-20 prescribes the mortality standard
to be used to compute the net premium reserves for the contracts. The NAIC changes
the Valuation Manual to require the use of
the Year 1 Commissioners’ Standard Ordinary (CSO) mortality tables to compute
the net premium reserves for all contracts
subject to VM-20. The requirement applies
to the determination of statutory reserves
for these contracts as of December 31,

611

Year 3. IC’s statutory reserves for each of
the contracts in the group of contracts as of
December 31, Year 3, will be lower than
they would have been had the NAIC not
changed the Valuation Manual to prescribe
the use of the Year 1 CSO mortality tables.
Situation 6. IC computes its reserves
for certain life insurance contracts under
VM‑20. Under VM-20, the minimum statutory reserve for the contracts is equal to
the sum of the policy minimum net premium reserves for the contracts, plus the
excess, if any, of the greater of the deterministic reserve for the contracts and the
stochastic reserve for the contracts. For the
taxable years ended December 31, Year 1,
and December 31, Year 2, the deterministic reserve exceeded both the stochastic
reserve and the sum of the policy net premium reserves for the contracts and thus
was the statutory reserve reported on the
NAIC annual statement. The excess of the
deterministic reserve over the sum of the
policy net premium reserves was allocated
to individual contracts in the manner prescribed by VM-20. IC’s statutory reserves
at December 31, Year 3, were equal to the
sum of the policy net premium reserves
for the contracts because this amount exceeded the deterministic reserve and stochastic reserve as of that date. There was
no change in the method of computing
the deterministic reserve, the stochastic
reserve, or the sum of the policy net premium reserves for the contracts in Year 3.
Situation 7. IC computes its reserves
for certain life insurance contracts under
VM‑20. Under VM-20, the minimum statutory reserve for the contracts is equal to
the sum of the policy minimum net premium reserves for the contracts, plus the
excess, if any, of the greater of the deterministic reserve for the contracts and the
stochastic reserve for the contracts. For the
taxable years ended December 31, Year 1,
and December 31, Year 2, the deterministic reserve exceeded both the stochastic
reserve and the sum of the policy net premium reserves for the contracts, and thus
was the statutory reserve reported on the
NAIC annual statement. Pursuant to the
requirements of VM-20, this excess was
allocated to individual contracts. For purposes of computing the deterministic reserve, section 9.c.2 of VM-20 requires that

September 28, 2020

company experience mortality rates be determined for each mortality segment and
that the company experience data used to
determine those rates be updated at least
every three years. Because of the VM-20
mandated update, the mortality rates used
for certain segments to compute the deterministic reserve as of December 31, Year
2, differed from those used for purposes of
computing the deterministic reserve as of
December 31, Year 1.
Situation 8. On its Federal income tax
return for the taxable year ended December 31, Year 1, IC reported tax reserves
for certain fixed annuity contracts equal
to 92.81% of the CARVM reserves for
the contracts, because that amount for
each contract exceeded the NSV for each
contract. For the taxable year ended December 31, Year 2, IC instead reported tax
reserves equal to the NSV of those same
contracts because that amount for each
contract was greater than 92.81% of the
CARVM reserve for each contract. There
was no change in the CARVM or in the
method of computing the NSV for any
contract in Year 2.
Situation 9. For purposes of computing
its life insurance reserves under § 807(d),
IC organizes its life insurance contracts
into policy groupings or cells, each consisting of policies that are identical as to
plan of insurance, year of issue or contract
duration, age of issue, and other factors.
In Year 2, after filing its Federal income
tax return for the Year 1 taxable year, IC
discovered that due to a computer programming error the policy cells for certain contracts issued during Year 1 had
been omitted from the computation of
IC’s closing Year 1 tax reserves. Had the
omitted policy cells been included in IC’s
closing Year 1 reserves, IC’s life insurance
reserves under § 807(d) at December 31,
Year 1, would have been greater than the
amounts originally claimed. The computer programming error took place in Year 1
and affected no other taxable year.
Situation 10. In Year 2, IC announced
to certain of its policyholders that their
policies would, at no increase in premium,
henceforth carry an additional indemnity
benefit should death result from a non-occupational vehicular accident. At the end
of Year 2, IC included in its reserves for the
relevant contracts an additional amount
for the present value of this additional fu-

September 28, 2020

ture unaccrued obligation. The additional
amount would be a life insurance reserve
under § 816(b) and was determined under
a tax reserve method within the meaning
of § 807(d)(2).
LAW AND ANALYSIS
Section 811(a) provides that a life insurance company is required to compute
its taxable income using an accrual method of accounting or, to the extent permitted under regulations prescribed by the
Secretary of the Treasury or his delegate
(Secretary), using a combination of an accrual method of accounting with another
permissible method (other than the cash
receipts and disbursements method). To
the extent not inconsistent with the requirement in the preceding sentence or
other Federal income tax rules applicable to life insurance companies, all such
computations, however, are to be made
in a manner consistent with the manner
required for purposes of the annual statement approved by the NAIC.
Section 803(a)(2) requires income to
be taken into account for any net decrease
in reserves described in § 807(c). Similarly, § 805(a)(2) authorizes a deduction for
any net increase in reserves described in
§ 807(c). Under § 807(c)(1), the reserves
to which this treatment applies include
“life insurance reserves (as defined in
§ 816(b)).”
Section 807(d)(1) provides rules for
determining the amount of life insurance
reserves other than for purposes of § 816
(relating to qualification as a life insurance company). In general, the amount of
the life insurance reserve with respect to
any contract is the greater of the NSV of
the contract or 92.81% of the reserve determined under § 807(d)(2). For a variable
contract, the reserve is the sum of (1) the
greater of the NSV of the contract and the
portion of the reserve separately accounted for under § 817 plus (2) 92.81% of the
excess of the total reserve determined under § 807(d)(2) over the NSV or § 817 reserve, as applicable.
Section 807(d)(2) provides that the reserve for any contract must be determined
using the tax reserve method applicable to
the contract. Section 807(d)(3) provides
that the applicable tax reserve method is
(1) in the case of a contract covered by

612

the CRVM, the CRVM prescribed by the
NAIC that is applicable to the contract and
in effect as of the date the reserve is determined and (2) in the case of a contract
covered by the CARVM, the CARVM
prescribed by the NAIC that is applicable
to the contract and in effect as of the date
the reserve is determined.
Section 807(f) provides that if the basis for determining any item referred to
in § 807(c), which includes life insurance
reserves, as of the close of any taxable
year differs from the basis for determining
that item as of the close of the preceding
taxable year, then so much of the difference between (1) the amount of the item
at the close of the taxable year, computed
on the new basis, and (2) the amount of
the item at the close of the taxable year,
computed on the old basis, as is attributable to contracts issued before the taxable
year, is taken into account under § 481(a)
as an adjustment attributable to a change
in method of accounting initiated by the
taxpayer and made with the consent of the
Secretary.
Section 1.807-4(a) of the Income Tax
Regulations provides that a change in
basis of computing an item referred to in
§ 807(c) is a change in method of accounting for purposes of § 1.446-1(e), unless
§ 1.446-1(e) provides otherwise. Accordingly, a change in basis under § 807(f) is
a change in method of accounting subject
to § 446(e) and the regulations thereunder.
In accordance with § 446(e) and § 1.4461(e), before computing an item described
in § 807(c) under a new basis, a life insurance company must obtain the consent of
the Commissioner of the Internal Revenue
or his delegate (Commissioner) pursuant
to administrative procedures prescribed
by the Commissioner. See section 26.04
of Rev. Proc. 2019-43, 2019-48 I.R.B.
1107 (or successor) (generally providing
the Commissioner’s automatic consent
for a life insurance company to change
its basis of computing an item referred to
in § 807(c)). Section 1.807-4(b) provides
rules relating to the required adjustments
under § 481(a). Section 1.807-4(c) describes how opening and closing balances
of § 807(c) items are determined under
§ 807(a) and (b) when there is a change in
basis under § 807(f).
As with the general rules for methods
of accounting, a company adopts a basis of

Bulletin No. 2020–40

computing an item referred to in § 807(c)
when it uses a permissible basis of computing the item on the first Federal income
tax return that reflects the item. If a company uses an impermissible basis of computing an item on the tax return for one
taxable year, such computation does not
constitute the adoption of a basis of computing the item. However, the consistent
use of an impermissible basis of computing an item on two or more consecutively
filed tax returns establishes the basis of
computing the item. If a company has adopted a basis of computing an item, it may
not change the basis by amending its prior
tax returns. See Rev. Rul. 90-38, 1990-1
C.B. 57; Rev. Rul. 2003-127, 2003-2 C.B.
1245; Thrasys, Inc. v. Commissioner, T.C.
Memo 2018-199. Additionally, a change
in an item referred to in § 807(c) resulting
from a change in underlying facts or from
the correction of mathematical or posting
errors is not a change in basis of computing the item under § 807(f). See § 1.4461(e)(2)(ii)(b).
In Situation 1, IC applied the 92.81%
factor of § 807(d) impermissibly on two
consecutively filed Federal income tax
returns – those for Year 1 and Year 2. IC
therefore adopted an impermissible basis
of computing reserves (old basis). Applying the 92.81% factor to the correct
portion of the reserve determined under
§ 807(d)(2) (new basis) for Year 3 (year
of change) is a change in basis under
§ 807(f). For the year of change, IC must
obtain the consent of the Commissioner to
make this change following the applicable
administrative guidance under § 446(e)
and § 1.446-1(e) and account for the difference between the tax reserve computed
on the new basis as of December 31, Year
3, and the tax reserve computed on the old
basis as of December 31, Year 3, attributable to contracts issued before Year 3, as
an adjustment under § 481(a).
In Situation 2, a change to VM-21 imposes a new computational requirement
as a component of CARVM on issuers
of variable annuities with guaranteed
minimum benefits (new basis). The requirement applies to the determination of
reserves as of December 31, Year 4 (year
of change), and revises the prior VM-21
requirements (old basis) with regard to
contracts issued after December 31, Year
1. Because for Federal income tax purpos-

Bulletin No. 2020–40

es § 807(d)(3)(B)(ii) requires the use of
the CARVM “which is applicable to the
contract and in effect as of the date the reserve is determined,” the change to VM21 is required to be taken into account for
purposes of applying § 807(d). The new
requirement represents a change in the
methodology for satisfying the CARVM
as prescribed by the NAIC. The change is
therefore a change in basis under § 807(f).
IC must obtain the consent of the Commissioner to make this change and must
account for the difference between the tax
reserve computed on the new basis as of
December 31, Year 4, and the tax reserve
computed on the old basis as of December
31, Year 4, attributable to contracts issued
after Year 1 and before Year 4 as an adjustment under § 481(a).
In Situation 3, as in Situation 2, the new
requirement (new basis) is a change in
the methodology for satisfying CARVM
and is therefore a change in basis under
§ 807(f). IC must obtain the consent of the
Commissioner to make this change. Because the change only applies to contracts
issued after Year 3, the change is made on
a cut-off basis and no adjustment is required under § 481(a). See section 2.07 of
Rev. Proc. 2015-13.
In Situation 4, a newly-issued Actuarial Guideline imposes a new computational
requirement for the CRVM for universal
life contracts (new basis). The requirement
applies to the determination of reserves as
of December 31, Year 3 (year of change),
and revises the prior CRVM requirements
(old basis) with regard to contracts issued
before Year 1. Because for Federal income
tax purposes § 807(d)(3)(B)(i) requires
the use of the CRVM “which is applicable to the contract and in effect as of the
date the reserve is determined,” the new
Actuarial Guideline is required to be taken into account for purposes of applying
§ 807(d). The new requirement represents
a change in the methodology for satisfying the CRVM prescribed by the NAIC.
The change is therefore a change in basis
under § 807(f). IC must obtain the consent
of the Commissioner to make this change
and account for the difference between the
tax reserve computed on the new basis as
of December 31, Year 3, and the tax reserve computed on the old basis as of December 31, Year 3, as an adjustment under
§ 481(a).

613

In Situation 5, a group of contracts that
is subject to VM-20 passes both the stochastic and deterministic exclusion tests
of VM-20, and IC elects to exclude the
group from both the stochastic and deterministic reserve calculations. As a result,
the statutory reserve with regard to each
contract is equal to the policy net premium
reserve, and the tax reserve is the greater
of 92.81% of this amount or the contract’s
NSV (old basis). The NAIC changes the
Valuation Manual to require the use of the
Year 1 CSO mortality tables to compute
the net premium reserves for all contracts
subject to VM-20 (new basis), effective
for the determination of statutory reserves
(and, as a result, tax reserves) as of December 31, Year 3 (year of change). IC’s
statutory reserves for each of the contracts
in the group of contracts will be lower
than they would have been had there not
been a change in tables. The new requirement represents a change in the methodology for satisfying the CRVM prescribed
by the NAIC. The change is therefore a
change in basis under § 807(f). IC must
obtain the consent of the Commissioner to
make this change and account for the difference between the tax reserve computed
on the new basis as of December 31, Year
3, and the tax reserve computed on the old
basis as of December 31, Year 3, as an adjustment under § 481(a).
In Situation 6, the comparison of the
sum of the policy net premium reserves
to the stochastic reserve and deterministic
reserve is required under VM-20, which is
the CRVM and the tax reserve method required to be used under § 807(d)(3). As a
result, a change from using the deterministic reserve to using the sum of the policy
net premium reserves is not a change in
basis but rather a function of the yearover-year change in those amounts. The
result would be the same if there had been
a statutory deterministic reserve in Years
1, 2, and 3, and under the terms of VM20 some contracts were not allocated any
deterministic reserve in Years 1 and 2 but
were allocated a portion of the deterministic reserve in Year 3.
In Situation 7, the statutory reserve for
the relevant contracts was equal to the deterministic reserve, and the mortality rates
that IC used for purposes of computing
the deterministic reserve as of December
31, Year 2, differed from those used for

September 28, 2020

purposes of computing the deterministic
reserve as of December 31, Year 1. The
rates were different, however, by reason
of a requirement of VM-20 that the company experience rates be determined for
each mortality segment and that experience data used to determine those rates
be updated at least every three years. The
update in mortality rates, therefore, was
by operation of the reserve methodology
of VM-20, which IC used consistently in
both Year 1 and Year 2. The change therefore is not a change in basis of computing
reserves.
In Situation 8, IC reported tax reserves as of December 31, Year 1, equal
to 92.81% of the CARVM reserve determined under § 807(d)(2) for certain of
its fixed annuity contracts because that
amount for each contract exceeded the
NSV for each of those contracts. It reported tax reserves as of December 31,
Year 2, equal to the NSV of the contracts
because this amount for each contract exceeded 92.81% of the CARVM reserve
determined under § 807(d)(2) for each
contract. Just as in Situation 6, where the
reserve methodology entailed a comparison of the deterministic reserve and the
sum of the policy net premium reserves,
here the reserve methodology entails
a comparison of two amounts, in this
case prescribed by § 807(d) itself. The
fact that year-over-year changes in these
amounts results in different calculated
amounts being taken into account does
not change the principle that the comparison is inherent in the reserve methodology itself, and applying that methodology
consistently is not a change in basis of
computing reserves.
In Situation 9, the understatement
of IC’s reserves at December 31, Year
1, caused by the omission of the policy
cells for certain contracts issued during
Year 1 is the result of a mathematical or
posting error. Correction of IC’s omission
of reserves for certain contracts is not a
change in basis of computing reserves.
See § 1.446-1(e)(2)(ii)(b). Because this
mathematical or posting error occurred
only on its Federal income tax return for
Year 1, IC should file an amended return
for that taxable year, restating the closing
reserves at December 31, Year 1, to reflect
the correct reserve amounts and taking
these recomputed reserves into account in

September 28, 2020

redetermining its life insurance company
taxable income for that year.
In Situation 10, there was no reserve
attributable to the new life insurance benefit at the close of Year 1 because the new
life insurance benefit did not exist before
the company became contractually liable for it in Year 2. The addition of the
new benefit in Year 2 is a change in fact.
An increase in reserve resulting from a
change in fact is not a change in basis of
computing reserves. See § 1.446-1(e)(2)
(ii)(b). Accordingly, the increase in reserves solely to provide for the additional
contractual obligation of IC pursuant to
the additional benefits provided during
Year 2 under existing policies is not attributable to a change in basis of computing reserves.

(9) In Situation 9, an inclusion of policy cells that were previously omitted on a
single return is a mathematical or posting
error that is not a change in basis.
(10) In Situation 10, the increase in reserves to provide solely for new benefits
on existing contracts is not a change in
basis.

HOLDINGS

26 CFR 1.163(j)-1 through -11, etc.

(1) In Situation 1, a change in the consistent, impermissible application of the
92.81% factor prescribed by § 807(d) is a
change in basis.
(2) In Situation 2, an NAIC Valuation
Manual change in the methodology for
computing reserves on previously-issued
contracts is a change in basis.
(3) In Situation 3, an NAIC Valuation
Manual change in the methodology for
computing reserves on contracts issued in
the year of the change is a change in basis.
(4) In Situation 4, a change in Actuarial
Guideline that results in a change in the
methodology for computing reserves is a
change in basis.
(5) In Situation 5, a change in the NAIC-prescribed mortality tables is a change
in basis.
(6) In Situation 6, a change under VM20 from the deterministic reserve to the
sum of the policy net premium reserves
due solely to the fact that the sum of the
policy net premium reserves is greater is
not a change in basis.
(7) In Situation 7, an experience-based
update in mortality rates as required by
VM‑20 to determine the deterministic reserve is not a change in basis.
(8) In Situation 8, a change from tax reserves based on 92.81% of the reserve determined under § 807(d)(2) to tax reserves
based on the contract NSV resulting solely
from a year-over-year change in which is
greater is not a change in basis.

614

DRAFTING INFORMATION
The principal author of this revenue
ruling is Ian Follansbee of the Office of
the Associate Chief Counsel (Financial
Institutions and Products). For further information regarding this revenue ruling
contact Ian Follansbee at 202-317-4453
(not a toll-free number).

T.D. 9905
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1
Limitation on Deduction for
Business Interest Expense
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations.
SUMMARY: This document contains final regulations providing guidance about
the limitation on the deduction for business interest expense after amendment of
the Internal Revenue Code (Code) by the
provisions commonly known as the Tax
Cuts and Jobs Act, which was enacted on
December 22, 2017, and the Coronavirus
Aid, Relief, and Economic Security Act,
which was enacted on March 27, 2020.
The regulations provide guidance to taxpayers on how to calculate the limitation,
what constitutes interest for purposes of
the limitation, which taxpayers and trades
or businesses are subject to the limitation,
and how the limitation applies in consolidated group, partnership, international,
and other contexts.

Bulletin No. 2020–40

DATES: Effective date: The regulations
are effective on November 13, 2020. Sections 1.163(j)-1 through 1.163(j)-11 are
generally applicable to taxable years beginning on or after November 13, 2020.
Applicability dates: For dates of applicability, see §§1.163(j)-1(c), 1.163(j)-2(k),
1.163(j)-3(d), 1.163(j)-4(g), 1.163(j)-5(h),
1.163(j)-6(p), 1.163(j)-9(k), 1.163(j)10(f), 1.163(j)-11(d), 1.263A-15(a),
1.381(c)(20)-1(d), 1.382-2(b)(3), 1.3825(f), 1.382-6(h), 1.383-1(j), 1.446-3(j)(2),
1.469-11(a)(3) and (4), 1.1502-36(h)(2),
1.1502-99(d), and 1.1504-4(i).
Pursuant to section 7805(b)(7), taxpayers and their related parties, within the
meaning of sections 267(b) and 707(b)(1),
may apply the rules set forth in §§1.163(j)1 through 1.163(j)-11, in their entirety, to
a taxable year beginning after December
31, 2017, and before November 13, 2020,
so long as the taxpayers and their related
parties consistently apply these rules, and,
if applicable, §§1.263A-9, 1.263A-15,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.382-5,
1.382-6, 1.382-7, 1.383-0, 1.383-1, 1.4699, 1,469-11, 1.704-1, 1.882-5, 1.1362-3,
1.1368-1, 1.1377-1, 1.1502-13, 1.150221, 1.1502-36, 1.1502-79, 1.1502-90,
1.1502-91 through 1.1502-99 (to the extent they effectuate the rules of §§1.3822, 1.382-5, 1.382-6, and 1.383-1), and
1.1504-4, to that taxable year. However,
see §1.163(j)-1(c) for the applicability
date rules relating to notional principal
contracts and the interest anti-avoidance
rule; see also part II(E)(2) (relating to notional principal contracts) and part II(E)
(4) (relating to the interest anti-avoidance
rule) of the Summary of Comments and
Revisions section of this preamble.
Alternatively, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may rely on
proposed §§1.163(j)-1 through 1.163(j)11, which were issued in a notice of proposed rulemaking (REG-106089-18) and
published on December 28, 2018, in the
Federal Register (83 FR 67490), in their
entirety, for a taxable year beginning after
December 31, 2017, and before November 13, 2020, so long as the taxpayers
and their related parties consistently apply proposed §§1.163(j)-1 through -11,
and, if applicable, proposed §§1.263A-9,
1.381(c)(20)-1, 1.382-1, 1.382-2, 1.3825, 1.382-6, 1.382-7, 1.383-0, 1.383-1,

Bulletin No. 2020–40

1.469-9, 1.469-11, 1.882-5, 1.1502-13,
1.1502-21, 1.1502-36, 1.1502-79, 1.150291 through 1.1502-99 (to the extent they
effectuate the rules of §§1.382-2, 1.3825, 1.382-6, and 1.383-1), and 1.1504-4,
to that taxable year. Notwithstanding the
preceding sentence, taxpayers applying
the provisions in the notice of proposed
rulemaking may apply §1.163(j)-1(b)(1)
(iii) in these final regulations for taxable
years beginning after December 31, 2017.
With respect to §1.382-2 and, if applicable, §§1.1502-91 through 1.1502-99
(to the extent they effectuate the rules of
§1.382-2), and with respect to §1.382-5
and, if applicable, §§1.1502-91 through
1.1502-99 (to the extent they effectuate
the rules of §1.382-5), the regulations apply to testing dates and ownership changes, respectively, occurring on or after November 13, 2020.
Taxpayers and their related parties,
within the meaning of sections 267(b) and
707(b)(1), may choose to apply the rules
of §1.382-2 and, if applicable, §§1.150291 through 1.1502-99 (to the extent they
effectuate the rules of §1.382-2), and
§1.382-5 and, if applicable, §§1.1502-91
through 1.1502-99 (to the extent they effectuate the rules of §1.382-5), to a testing
date or an ownership change, respectively, that occurs in a taxable year beginning
after December 31, 2017, and before November 13, 2020, so long as the taxpayers
and their related parties consistently apply the rules of §§1.163(j)-1 through -11,
1.382-1, 1.382-2, 1.382-5, 1.382-6, 1.3827, 1.383-0, and 1.383-1, and, if applicable, §§1.263A-9, 1.263A-15, 1.381(c)
(20)-1, 1.469-9, 1.469-11, 1.704-1, 1.8825, 1.1362-3, 1.1368-1, 1.1377-1, 1.150213, 1.1502-21, 1.1502-36, 1.1502-79,
1.1502-90, 1.1502-91 through 1.1502-99
(to the extent they effectuate the rules of
§§1.382-2, 1.382-5, 1.382-6, and 1.3831), and 1.1504-4, to that taxable year.
Alternatively, taxpayers and their related parties, within the meaning of sections 267(b) and 707(b)(1), may rely on
the rules of proposed §1.382-2 and, if
applicable, §§1.1502-91 through 1.150299 (to the extent they effectuate the rules
of §1.382-2), and §1.382-5 and, if applicable, §§1.1502-91 through 1.1502-99
(to the extent they effectuate the rules of
§1.382-5), which were issued in a notice
of proposed rulemaking (REG-106089-

615

18) and published on December 28, 2018,
in the Federal Register (83 FR 67490),
with respect to a testing date or an ownership change, respectively, that occurs in
a taxable year beginning after December
31, 2017, and before November 13, 2020,
so long as the taxpayers and their related
parties consistently apply the rules of proposed §§1.163(j)-1 through -11, 1.382-1,
1.382-2, 1.382-5, 1.382-6, 1.382-7, 1.3830, and 1.383-1, and, if applicable, proposed
§§1.263A-9, 1.381(c)(20)-1, 1.469-9,
1.469-11, 1.882-5, 1.1502-13, 1.1502-21,
1.1502-36, 1.1502-79, 1.1502-90, 1.150291 through 1.1502-99 (to the extent they
effectuate the rules of §§1.382-2, 1.3825, 1.382-6, and 1.383-1), and 1.1504-4,
to that taxable year. As noted previously,
taxpayers relying on the provisions in the
notice of proposed rulemaking may apply
§1.163(j)-1(b)(1)(iii) in these final regulations for taxable years ending after December 31, 2017.
FOR
FURTHER
INFORMATION
CONTACT: Concerning §1.163(j)-1,
§1.163(j)-2, §1.163(j)-3, §1.163(j)-9,
§1.263A-9, or §1.263A-15, Sophia Wang,
(202) 317-4890 or Justin Grill, (202) 3174850; concerning §1.163(j)-4, §1.163(j)5, §1.163(j)-10, §1.163(j)-11, §1.381(c)
(20)-1, §1.382-1, §1.382-2, §1.382-5,
§1.382-6, §1.382-7, §1.383-0, §1.3831, §1.1502-13, §1.1502-21, §1.1502-36,
§1.1502-79, §1.1502-90, §1.1502-91,
§1.1502-95, §1.1502-98, §1.1502-99, or
§1.1504-4, Russell Jones, (202) 317-5357,
John Lovelace, (202) 317-5363, Aglaia
Ovtchinnikova, (202) 317-6975, or Marie C. Milnes-Vasquez, (202) 317-3181;
concerning §1.163(j)-6, §1.469-9(b)(2),
§1.469-11, §1.704-1, §1.1362-3, §1.13681, or §1.1377-1, William Kostak, (202)
317-6852, Anthony McQuillen, (202) 3175027, or Adrienne Mikolashek, (202) 3175050; concerning §1.163(j)-7, §1.163(j)8, or §1.882-5, Azeka Abramoff, (202)
317-3800, Angela Holland, (202) 3175474, or Steve Jensen, (202) 317-6938;
concerning §1.446-3, §1.860C-2, RICs,
REITs, REMICs, and the definition of the
term “interest”, Michael Chin, (202) 3175846 (not toll-free numbers).
ADDRESSES: Submit electronic submissions to the Federal eRulemaking Portal
at http://www.regulations.gov (indicate

September 28, 2020

IRS and REG-106089-18) by following
the online instructions for submitting
comments. Once submitted to the Federal eRulemaking Portal, comments cannot
be edited or withdrawn. The Department
of the Treasury (Treasury Department)
and the Internal Revenue Service (IRS)
will publish for public availability any
comment received to its public docket,
whether submitted electronically or in
hard copy. Send hard copy submissions
to CC:PA:LPD:PR (REG-106089-18),
Room 5203, Internal Revenue Service,
P.O. Box 7604, Ben Franklin Station,
Washington, DC 20044.
SUPPLEMENTARY INFORMATION:
Background
Table of Contents
I. Overview
II. Comments on and Changes to Proposed §1.163(j)-1: Definitions
A. Definition and Calculation of Adjusted Taxable Income (ATI) – Proposed
§1.163(j)-1(b)(1)
1. Taxable Income and Tentative Taxable
Income
2. Adjustments to ATI for Amounts Incurred as Depreciation, Amortization, and
Depletion
3. ATI and Floor Plan Financing Interest
4. Adjustments to Taxable Income in
Computing ATI Under Section 163(j)(8)
(A)
5. Certain Adjustments to Tentative Taxable Income in Computing ATI Under
Section 163(j)(8)(B)
6. Adjustments to Adjusted Taxable Income in Respect of United States Shareholders of CFCs
B. Definition of Business Interest Expense
– Proposed §1.163(j)-1(b)(2)
C. Definition of Excepted Regulated Utility Trade or Business – Proposed §1.163(j)1(b)(13)
D. Definition of Floor Plan Financing Interest Expense – Proposed §1.163(j)-1(b)
(17)
E. Definition of Interest – Proposed
§1.163(j)-1(b)(20)
1. In General
2. Swaps with Significant Nonperiodic
Payments
3. Other Amounts Treated as Interest

September 28, 2020

i. Items Relating to Premium, Ordinary
Income or Loss on Certain Debt Instruments, Section 1258 Gain, and Factoring
Income
ii. Substitute Interest Payments
iii. Commitment Fees
iv. Debt Issuance Costs
v. Guaranteed Payments
vi. Hedging Transactions
vii. Other Items
a. Dividends from Regulated Investment
Company (RIC) Shares
b. MMF Income
c. Negative Interest
d. Leases
4. Anti-Avoidance Rule for Amounts Predominantly Associated with the Time
Value of Money
5. Authority Comments
F. Definition of Motor Vehicle – Proposed
§1.163(j)-1(b)(25)
G. Definition of Taxable Income – Proposed §1.163(j)-1(b)(37)
1. Calculation of Taxable Income
2. Interaction with Section 250
3. When Disallowed Business Interest Expense is “Paid or Accrued”
4. Interaction with Sections 461(l), 465,
and 469 – Proposed §1.163(j)-1(b)(37)
H. Definition of Trade or Business – Proposed §1.163(j)-1(b)(38)
1. In General
2. Multiple Trades or Businesses Within
an Entity
3. Rental Real Estate Activities as a Trade
or Business
4. Separate Entities
I. Applicability Dates
III. Comments on and Changes to Proposed §1.163(j)-2: Deduction for Business Interest Expense Limited
A. Whether the Section 163(j) Limitation
is a Method of Accounting
B. General Gross Receipts Test and Aggregation
C. Small Business Exemption and Single
Employer Aggregation Rules – Proposed
§§1.163(j)-2(d) and 1.52-1(d)(1)(i)
D. Small Business Exemption and Tax
Shelters - Proposed §1.163(j)-2(d)(1)
E. Gross Receipts for Partners in Partnerships and Shareholders of S Corporation
Stock – Proposed §1.163(j)-2(d)(2)(iii)
IV. Comments on and Changes to Section
Proposed §1.163(j)-3: Relationship of
Section 163(j) Limitation to Other Provisions Affecting Interest

616

A. Capitalized Interest
B. Provisions that Characterize Interest
Expense as Something Other Than Business Interest Expense
C. Section 108
D. Sections 461(l), 465, and 469
V. Comments on and Changes to Proposed
§1.163(j)-4: General Rules Applicable to
C Corporations (Including Real Estate Investment Trusts (REITs), RICs, and Members of Consolidated Groups) and Tax-Exempt Corporations
A. Aggregating Affiliated but Non-Consolidated Entities
B. Intercompany Transactions and Intercompany Obligations
C. Repurchase Premium on Obligations
that are Deemed Satisfied and Reissued
D. Intercompany Transfers of Partnership
Interests
1. Overview of Proposed §1.163(j)-4(d)
(4)
2. Intercompany Transfers of Partnership Interests Treated as Dispositions;
Single-Entity Treatment; Application of
§1.1502-13
3. Possible Approach to Intercompany
Partnership Interest Transfers
4. Offsetting Excess Business Interest Expense and Adjusted Taxable Income Within the Consolidated Group
5. Intercompany Nonrecognition Transactions
6. Basis Adjustments Under §1.1502-32
7. Partnership Terminations
E. Application of §1.1502-36 to Excess
Business Interest Expense
F. Calculating ATI for Cooperatives
G. Calculating ATI for a Consolidated
Group
H. Application of Section 163(j) to
Life-Nonlife Groups
I. Application of Section 163(j) to Tax-Exempt Entities
J. Partnership Investment Income and
Corporate Partners
K. Earnings and Profits of a Corporate
Partner
VI. Comments on and Changes to Proposed §1.163(j)-5: General Rules Governing Disallowed Business Interest Expense
Carryforwards for C Corporations
A. Absorption of Disallowed Business Interest Expense Carryforwards Before Use
of NOLs in Life-Nonlife Groups
B. Carryforwards from Separate Return
Limitation Years

Bulletin No. 2020–40

C. Offsetting Business Interest Expense
with Business Interest Income and Floor
Plan Financing Interest Expense at the
Member Level
VII. Comments on and Changes to Section 1.163(j)-6: Application of the Business Interest Expense Deduction Limitations to Partnerships and Subchapter S
Corporations
A. Partnership-Level Calculation and Allocation of Section 163(j) Excess Items
1. Nonseparately Stated Taxable Income
or Loss of the Partnership
2. Requested Clarifications and Modifications
3. Recommended Alternative Methods
4. Publicly Traded Partnerships
5. Pro Rata Exception
B. Basis Adjustments
1. Basis and Capital Account Adjustments
for Excess Business Interest Expense Allocations
2. Basis Adjustments Upon Disposition of
Partnership Interests Pursuant to Section
163(j)(4)(B)(iii)(II)
3. Intercompany Transfer of a Partnership
Interest
C. Debt-Financed Distributions
D. Trading Partnerships
E. Treatment of Excess Business Interest
Expense in Tiered Partnerships
F. Partnership Mergers and Divisions
G. Applicability of Section 382 to S Corporations Regarding Disallowed Business
Interest Expense Carryforwards
H. Separate Application of Section 163(j)
Limitation to Short Taxable Years of S
Corporation
I. Partnership or S Corporation Not Subject to Section 163(j)
J. Trusts
K. Qualified Expenditures
L. CARES Act Partnership Rules
VIII. Comments on and Changes to Proposed §1.163(j)-7: Application of the Section 163(j) Limitation to Foreign Corporations and United States Shareholders
IX. Comments on and Changes to Section 1.163(j)-8: Application of the Section 163(j) Limitation to Foreign Persons
with Effectively Connected Taxable Income.
X. Comments on and Changes to Proposed §1.163(j)-9: Elections for Excepted Trades or Businesses; Safe Harbor for
Certain REITs
A. Protective Elections

Bulletin No. 2020–40

B. One-Time Late Election or Withdrawal
of Election Procedures
C. The Anti-Abuse Rule Under Proposed
§1.163(j)-9(h)
D. Residential Living Facilities and Notice with Proposed Revenue Procedure
E. Safe Harbor for Certain REITs
F. Real Property Trade or Business
XI. Comments on and Changes to Proposed §1.163(j)-10: Allocation of Interest Expense, Interest Income, and Other
Items of Expense and Gross Income to an
Excepted Trade or Business.
A. General Method of Allocation: Asset
Basis
B. Allocation Between Trades or Businesses and Non-Trades or Businesses
C. Consolidated Groups
1. Overview
2. Intercompany Transactions
3. Use of Property Derives from an Intercompany Transaction
4. Purchase of Member Stock from a Nonmember
5. Inclusion of Income from Excepted
Trades or Businesses in Consolidated ATI
6. Engaging in Excepted or Non-Excepted
Trades or Businesses as a “Special Status”
D. Quarterly Asset Testing
E. De Minimis Rules
1. Overview
2. Order in Which the De Minimis Rules
Apply
3. Mandatory Application of De Minimis
Rules
4. De Minimis Threshold for Electric Cooperatives
5. Standardization of 90 Percent De Minimis Tests
6. Overlapping De Minimis Tests
F. Assets Used in More than One Trade or
Business
1. Overview
2. Consistency Requirement
3. Changing a Taxpayer’s Allocation
Methodology
4. Mandatory Use of Relative Output for
Utility Trades or Businesses
G. Exclusions from Basis Calculations
H. Look-Through Rules
1. Ownership Thresholds; Direct and Indirect Ownership Interests
2. Application of Look-Through Rules to
Partnerships
i. In General
ii. Coordination of Look-Through Rule
and Basis Determination Rules

617

iii. Applying the Look-Through Rule and
Determining Share of Partnership Basis
iv. Investment Asset Basis Reduction Rule
v. Coordination of Section 752 Basis Reduction Rule and Investment Asset Basis
Reduction Rule
vi. Allocating Basis in a Partnership Interest Between Excepted and Non-Excepted
Trades or Businesses
3. Additional Limitation on Application of
Look-Through Rules to C Corporations
4. Dispositions of Stock in Non-Consolidated C Corporations
5. Application of Look-through Rules to
Small Businesses
6. Application of the Look-Through Rules
to Foreign Utilities
I. Deemed Asset Sale
J. Carryforwards of Disallowed Disqualified Interest
K. Anti-Abuse Rule
L. Direct Allocation
1. Overview
2. Expansion of the Direct Allocation Rule
3. Basis Reduction Requirement for Qualified Nonrecourse Indebtedness
4. Direct Allocation Rule for Financial
Services Businesses
XII. Comments on Proposed Changes to
§1.382-2: General Rules for Ownership
Change
XIII. Comments on Proposed Changes to
§1.382-6: Allocation of Income and Loss
to Periods Before and After the Change
Date for Purposes of Section 382
XIV. Comments on and Changes to Proposed §1.383-1: Special Limitations on
Certain Capital Losses and Excess Credits
XV. Other Comments about Section 382
A. Application of Section 382(l)(5)
B. Application of Section 382(e)(3)
C. Application of Section 382(h)(6)
XVI. Definition of Real Property Trade or
Business
This document contains amendments
to the Income Tax Regulations (26 CFR
part 1) under section 163(j) of the Code.
The final regulations reflect amendments
to section 163(j) made by Public Law 11597, 131 Stat. 2054 (December 22, 2017),
commonly referred to as the Tax Cuts and
Jobs Act (the TCJA) and the Coronavirus Aid, Relief, and Economic Security
Act, Public Law No. 116-136 (2020) (the
CARES Act). Section 13301(a) of the
TCJA amended section 163(j) by remov-

September 28, 2020

ing prior section 163(j)(1) through (9) and
adding section 163(j)(1) through (10) and
significantly changed the limitation for
deducting interest on certain indebtedness. The provisions of section 163(j) as
amended by section 13301 of the TCJA
are effective for tax years beginning after
December 31, 2017. The CARES Act further amended section 163(j) by redesignating section 163(j)(10), as amended by
the TCJA, as new section 163(j)(11), and
adding a new section 163(j)(10) providing
special rules for applying section 163(j) to
taxable years beginning in 2019 or 2020.
All references to “old section 163(j)” in
this document are references to section
163(j) prior to amendment by the TCJA
and the CARES Act, and all references to
“section 163(j)” are references to section
163(j) as amended by the TCJA and the
CARES Act.
Old section 163(j) generally disallowed a deduction for “disqualified interest” paid or accrued by a corporation in
a taxable year if the payor’s debt-to-equity ratio exceeded 1.5 to 1.0, and if the
payor’s net interest expense exceeded 50
percent of its adjusted taxable income.
Disqualified interest included interest
paid or accrued to (1) related parties
when no Federal income tax was imposed
with respect to such interest; (2) unrelated parties in certain instances in which
a related party guaranteed the debt; or
(3) certain real estate investment trusts
(REIT). Interest amounts disallowed for
any taxable year under old section 163(j)
were treated as interest paid or accrued in
the succeeding taxable year and could be
carried forward indefinitely. In addition,
any excess limitation, the excess of the
taxpayer’s net interest expense over 50
percent of its adjusted taxable income,
could be carried forward three years.
The interest limitation under old section
163(j) was designed to prevent a taxpayer from deducting interest from its U.S.
taxable income without a corresponding
inclusion in U.S. taxable income by the
recipient, or to prevent the stripping of
earnings from the U.S. tax system.
In contrast, section 163(j) now applies
broadly to all business interest expense regardless of whether the related indebtedness is between related parties or incurred
by a corporation, and regardless of the
taxpayer’s debt-to-equity ratio. Section

September 28, 2020

163(j) provides an entirely new limitation
on the deduction for “business interest
expense” of all taxpayers, including, for
example, individuals, corporations, partnerships, S corporations, unless a specific exclusion applies under section 163(j).
Although certain terms are used in both
old section 163(j) and section 163(j), such
as “adjusted taxable income,” such terms
have been updated in the final regulations
to reflect the new limitation under section
163(j).
Section 163(j) generally limits the
amount of business interest expense that
can be deducted in the current taxable
year (also referred to in this preamble as
the current year). Under section 163(j)
(1), the amount allowed as a deduction
for business interest expense is limited
to the sum of (1) the taxpayer’s business
interest income for the taxable year; (2)
30 percent of the taxpayer’s adjusted taxable income (ATI) for the taxable year
(30 percent ATI limitation); and (3) the
taxpayer’s floor plan financing interest
expense for the taxable year. As further
described later in this Background section, section 163(j)(10), as amended by
the CARES Act, provides special rules
relating to the 30 percent ATI limitation
for taxable years beginning in 2019 or
2020. The section 163(j) limitation applies to all taxpayers, except for certain
small businesses that meet the gross receipts test in section 448(c) and certain
trades or businesses listed in section
163(j)(7).
Section 163(j)(2) provides that the
amount of any business interest not allowed as a deduction for any taxable year
as a result of the section 163(j) limitation
is carried forward and treated as business
interest paid or accrued in the next taxable year. In contrast to old section 163(j),
section 163(j) does not allow the carryforward of any excess limitation.
Section 163(j)(3) provides that the
section 163(j) limitation does not apply
to a taxpayer, other than a tax shelter as
described in section 448(a)(3), with average annual gross receipts of $25 million
or less, determined under section 448(c)
(including any adjustment for inflation under section 448(c)(4)). For taxpayers other
than corporations or partnerships, section
163(j)(3) provides that the gross receipts
test is determined for purposes of section

618

163(j) as if the taxpayer were a corporation or partnership.
Section 163(j)(4) provides special
rules for applying section 163(j) in the
case of partnerships and S corporations.
Section 163(j)(4)(A) requires that the
limitation on the deduction for business
interest expense be applied at the partnership level, and that a partner’s ATI be
increased by the partner’s share of the
partnership’s excess taxable income, as
defined in section 163(j)(4)(C), but not
by the partner’s distributive share of the
partnership’s income, gain, deduction,
or loss. Section 163(j)(4)(B)(i) provides
that the amount of partnership business
interest expense limited by section 163(j)
(1) is carried forward at the partner level.
Section 163(j)(4)(B)(ii) provides that excess business interest expense allocated
to a partner and carried forward is available to be deducted in a subsequent year
only if, and to the extent, the partnership
allocates excess taxable income to the
partner. As further described later in this
Background section, section 163(j)(10)
(A)(ii)(II), as amended by the CARES
Act, provides a special rule for excess
business interest expense allocated to
a partner in a taxable year beginning in
2019. Section 163(j)(4)(B)(iii) provides
basis adjustment rules for a partner that
is allocated excess business interest expense. Section 163(j)(4)(D) provides that
rules similar to the rules of section 163(j)
(4)(A) and (C) apply to S corporations
and S corporation shareholders.
Section 163(j)(5) and (6) defines “business interest” and “business interest income,” respectively, for purposes of section 163(j). Generally, these terms include
interest expense and interest includible in
gross income that is properly allocable to
a trade or business (as defined in section
163(j)(7)) and do not include investment
income or investment expense within the
meaning of section 163(d). The legislative history states that “a corporation has
neither investment interest nor investment
income within the meaning of section
163(d). Thus, interest income and interest
expense of a corporation is properly allocable to a trade or business, unless such
trade or business is otherwise explicitly
excluded from the application of the provision.” H. Rept. 115-466, at 386, fn. 688
(2017).

Bulletin No. 2020–40

Under section 163(j)(7), the limitation
on the deduction for business interest expense in section 163(j)(1) does not apply
to certain trades or businesses (excepted
trades or businesses). The excepted trades
or businesses are the trade or business of
providing services as an employee, electing real property businesses, electing
farming businesses, and certain regulated
utility businesses.
Section 163(j)(8) defines ATI as the
taxable income of the taxpayer without
regard to the following: items not properly allocable to a trade or business;
business interest and business interest
income; net operating loss (NOL) deductions; and deductions for qualified business income under section 199A. ATI
also generally excludes deductions for
depreciation, amortization, and depletion
with respect to taxable years beginning
before January 1, 2022, and it includes
other adjustments provided by the Secretary of the Treasury.
Section 163(j)(9) defines “floor plan
financing interest” as interest paid or accrued on “floor plan financing indebtedness.” These provisions allow taxpayers
incurring interest expense for the purpose
of securing an inventory of motor vehicles
held for sale or lease to deduct the full expense without regard to the section 163(j)
limitation.
Under section 163(j)(10)(A)(i), the
amount of business interest that is deductible under section 163(j)(1) for taxable years beginning in 2019 or 2020 is
computed using 50 percent, rather than
30 percent, of the taxpayer’s ATI for the
taxable year (50 percent ATI limitation).
A taxpayer may elect not to apply the 50
percent ATI limitation to any taxable year
beginning in 2019 or 2020, and instead
apply the 30 percent ATI limitation. The
election must be made separately for each
taxable year. Once the taxpayer makes the
election, the election may not be revoked
without the consent of the Secretary of
the Treasury or his delegate. See section
163(j)(10)(A)(iii).
Sections 163(j)(10)(A)(ii)(I) and 163(j)
(10)(A)(iii) provide that, in the case of a
partnership, the 50 percent ATI limitation
does not apply to partnerships for taxable
years beginning in 2019, and the election
to not apply the 50 percent ATI limitation
may be made only for taxable years begin-

Bulletin No. 2020–40

ning in 2020. This election may be made
only by the partnership and may not be
revoked without the consent of the Secretary of the Treasury or his delegate. Under
section 163(j)(10)(A)(ii)(II), however, a
partner treats 50 percent of its allocable
share of a partnership’s excess business
interest expense for 2019 as a business interest expense in the partner’s first taxable
year beginning in 2020 that is not subject
to the section 163(j) limitation (50 percent
EBIE rule). The remaining 50 percent of
the partner’s allocable share of the partnership’s excess business interest expense
remains subject to the section 163(j) limitation applicable to excess business interest expense carried forward at the partner
level. A partner may elect out of the 50
percent EBIE rule.
Section 163(j)(10)(B)(i) allows a taxpayer to elect to use its ATI for the last
taxable year beginning in 2019 for the taxpayer’s ATI in determining the taxpayer’s
section 163(j) limitation for any taxable
year beginning in 2020.
Section 163(j)(11) provides cross-references to provisions requiring that electing farming businesses and electing real
property businesses excepted from the
section 163(j) limitation use the alternative depreciation system (ADS), rather
than the general depreciation system for
certain types of property. The required
use of ADS results in the inability of these
electing trades or businesses to use the additional first-year depreciation deduction
under section 168(k) for those types of
property.
On December 28, 2018, the Treasury
Department and the IRS (1) published
proposed regulations under section 163(j)
in a notice of proposed rulemaking (REG106089-18) (proposed regulations) in the
Federal Register (83 FR 67490), and (2)
withdrew the notice of proposed rulemaking (1991-2 C.B. 1040) published in the
Federal Register on June 18, 1991 (56
FR 27907) (as corrected by 56 FR 40285
(August 14, 1991)) to implement rules
under old section 163(j) (1991 Proposed
Regulations). The proposed regulations
were issued following guidance announcing and describing regulations intended to
be issued under section 163(j). See Notice
2018-28, 2018-16 I.R.B. 492.
A public hearing was held on February 27, 2019. The Treasury Department

619

and the IRS received written comments
responding to the notice of proposed
rulemaking. Comments received before
the final regulations were substantially
developed, including all comments received on or before the deadline for comments on February 26, 2019, were carefully considered in developing the final
regulations.
Copies of the comments received are
available for public inspection at http://
www.regulations.gov or upon request.
After consideration of the comments received and the testimony at the public
hearing, this Treasury decision adopts
the proposed regulations as revised in response to such comments and testimony
as described in the Summary of Comments and Explanation of Revisions section. The revisions are discussed in this
preamble. Concurrently with the publication of the final regulations, the Treasury
Department and the IRS are publishing
in the Proposed Rule section of this edition of the Federal Register (RIN 1545BO76) a notice of proposed rulemaking
providing additional proposed regulations under section 163(j) (REG-10791118) (Concurrent NPRM). The Concurrent
NPRM includes proposed regulations relating to changes made to section 163(j)
under the CARES Act.
On September 10, 2019, the Treasury
Department and the IRS published proposed regulations under section 382(h)
(REG-125710-18) in the Federal Register (84 FR 47455) (the September 2019
section 382 proposed regulations). The
September 2019 section 382 proposed
regulations included a rule to clarify that
section 382 disallowed business interest
carryforwards are not treated as recognized built-in losses (RBILs). No formal
comments were received on this rule
during the comment period for the September 2019 section 382 proposed regulations.
On April 10, 2020, the Treasury Department and the IRS released Revenue
Procedure 2020-22, 2020-18 I.R.B. 745,
to provide the time and manner of making
a late election, or withdrawing an election under section 163(j)(7)(B) to be an
electing real property trade or business, or
under section 163(j)(7)(C) to be an electing farming business, for taxable years
beginning in 2018, 2019, or 2020. Reve-

September 28, 2020

nue Procedure 2020-22 also provides the
time and manner of making or revoking
elections provided by the CARES Act
under section 163(j)(10) for taxable years
beginning in 2019 or 2020. As described
earlier in this Background section, these
elections are: (1) to not apply the 50 percent ATI limitation under section 163(j)
(10)(A)(iii); (2) to use the taxpayer’s ATI
for the last taxable year beginning in 2019
to calculate the taxpayer’s section 163(j)
limitation in 2020 under section 163(j)
(10)(B); and (3) for a partner to elect out
of the 50 percent EBIE rule under section
163(j)(10)(A)(ii)(II).
Summary of Comments and
Explanation of Revisions
I. Overview
The Treasury Department and the
IRS received approximately 120 written
comments in response to the notice of
proposed rulemaking. Most of the comments addressing the proposed regulations are summarized in this Summary
of Comments and Explanation of Revisions section. However, comments merely
summarizing or interpreting the proposed
regulations or recommending statutory revisions generally are not discussed in this
preamble. Additionally, comments outside
the scope of this rulemaking are generally
not addressed in this Summary of Comments and Explanation of Revisions section.
The Treasury Department and the IRS
continue to study comments on certain
issues related to section 163(j), including
issues that are beyond the scope of the final regulations (or the Concurrent NPRM
in the Proposed Rules section of this issue
of the Federal Register), and may discuss
those comments if future guidance on
those issues is published.
The final regulations retain the same
basic structure as the proposed regulations, with certain revisions.
II. Comments on and Changes to
Proposed §1.163(j)-1: Definitions
Section 1.163(j)-1 provides definitions
of the terms used in the final regulations.
The following discussion addresses comments relating to proposed §1.163(j)-1.

September 28, 2020

A. Definition and Calculation of Adjusted
Taxable Income (ATI) – Proposed
§1.163(j)-1(b)(1)

2. Adjustments to ATI for Amounts
Incurred as Depreciation, Amortization,
and Depletion

1. Taxable Income and Tentative Taxable
Income

Section 163(j)(8)(A)(v) defines ATI as
the taxable income of the taxpayer computed without regard to certain items,
including any deduction allowable for depreciation, amortization, or depletion for
taxable years beginning before January
1, 2022. Consistent with section 163(j)
(8)(A)(v), proposed §1.163(j)-1(b)(1)(i)
requires an addback to taxable income of
deductions for depreciation, amortization,
and depletion for taxable years beginning
before January 1, 2022. In general, section
263A requires certain taxpayers that manufacture or produce inventory to capitalize
all direct costs and certain indirect costs
into the basis of the property produced or
acquired for resale. Depreciation, amortization or depletion that is capitalized
into inventory under section 263A is recovered through cost of goods sold as an
offset to gross receipts in computing gross
income; cost of goods sold reduces the
amount realized upon the sale of goods
that is used to calculate gross income and
is technically not a deduction that is applied against gross income in determining taxable income. See §§1.61-3(a) and
1.263A-1(e)(3)(ii)(I) and (J). Thus, proposed §1.163(j)-1(b)(1)(iii) provides that
depreciation, amortization, or depletion
expense capitalized into inventory under
section 263A is not a depreciation, amortization, or depletion deduction, that may
be added back to taxable income in computing ATI. The preamble to the proposed
regulations further noted that an amount
that is incurred as depreciation, amortization, or depletion, but that is capitalized
to inventory under section 263A and included in costs of goods sold, is not a deduction for depreciation, amortization, or
depletion for purposes of section 163(j).
Many commenters raised questions and
concerns regarding proposed §1.163(j)1(b)(1)(iii) and requested that the addback
of deductions for depreciation, amortization, and depletion include any amount
that is required to be capitalized into inventory under section 263A. First, commenters stated that the provision does not
reflect congressional intent, which was
to determine ATI using earnings before
interest, tax, depreciation, and amortiza-

Consistent with section 163(j)(8), proposed §1.163(j)-1(b)(1) defines ATI as the
“taxable income” of the taxpayer for the
taxable year, with certain specified adjustments. Thus, in calculating ATI, the
proposed regulations begin with taxable
income as the amount to which adjustments are made when calculating ATI.
Proposed §1.163(j)-1(b)(37)(i) generally
provides that the term “taxable income”
has the meaning provided in section 63,
but for purposes of section 163(j), is computed without regard to the application
of section 163(j) and the section 163(j)
regulations. However, in some instances
in the section 163(j) regulations the term
“taxable income” is used to indicate the
amount calculated under section 63 for
purposes other than calculating ATI.
To prevent confusion from using the
term “taxable income” in different contexts (in determining ATI, and for purposes other than determining ATI), the final
regulations use a new term, “tentative
taxable income,” to refer to the amount to
which adjustments are made in calculating ATI. See §1.163(j)-1(b)(43). Tentative
taxable income is generally determined in
the same manner as taxable income under
section 63, but is computed without regard
to the application of the section 163(j)
limitation, and without regard to any disallowed business interest expense carryforwards. This definitional change avoids
confusion with section 63 taxable income,
avoids creating an iterative loop that takes
into account the section 163(j) limitation,
and ensures that disallowed business interest expense carryforwards are taken
into account only once in testing business
interest expense against the limitation.
Therefore, “tentative taxable income”
is used in the final regulations and, where
appropriate, in this Summary of Comments and Explanation of Provisions section, to describe the starting point for the
calculation of ATI in the final regulations.
See part II(G)(1) of this Summary of
Comments and Explanation of Revisions
section.

620

Bulletin No. 2020–40

tion (EBITDA) through taxable year 2021
and using earnings before interest and tax
(EBIT) thereafter. Commenters noted that
the proposed rule would eliminate this
distinction for certain manufacturers or
producers of property for sale. Commenters pointed out that capital-intensive businesses that manufacture or produce inventory are at a disadvantage in comparison
to other types of businesses because the
manufacturers or producers would have
to compute ATI without an addback for a
substantial amount of their depreciation,
and that neither section 163(j) nor its legislative history indicates an intent by Congress to treat manufacturers or producers
of inventory differently from other trades
or businesses. Commenters also contrasted the language in section 163(j)(8)(A)
(iv), which allows an addback of “the
amount of any deduction allowed under
section 199A,” with section 163(j)(8)(A)
(v), which allows an addback of “any deduction allowable for depreciation, amortization, or depletion” (emphasis added).
The phrase “allowed or allowable” is
used in other Code provisions. Section
1016(a)(2) provides that, in calculating
tax basis, adjustments are required for depreciation to the extent such amounts are
allowed as deductions in computing taxable income but not less than the amounts
allowable. Some commenters noted that
depreciation allowable as a deduction for
purposes of section 1016(a)(2) should be
read consistently with depreciation allowable as a deduction for purposes of section
163(j), and that section 1016(a)(2) treats
depreciation capitalized into inventory under section 263A as deductions allowable.
As provided in section 263A(a)(2) and
§1.263A-1(c)(2), an amount is not subject
to capitalization under section 263A unless such cost may be taken into account
in computing taxable income.
The Treasury Department and the IRS
have reconsidered proposed §1.163(j)1(b)(1)(iii). Accordingly, under the final
regulations, the amount of any depreciation, amortization, or depletion that is capitalized into inventory under section 263A
during taxable years beginning before
January 1, 2022, is added back to tentative
taxable income as a deduction for depreciation, amortization, or depletion when calculating ATI for that taxable year, regardless of the period in which the capitalized

Bulletin No. 2020–40

amount is recovered through cost of goods
sold. For example, if a taxpayer capitalized an amount of depreciation to inventory under section 263A in the 2020 taxable
year, but the inventory is not sold until the
2021 taxable year, the entire capitalized
amount of depreciation is added back to
tentative taxable income in the 2020 taxable year, and such capitalized amount of
depreciation is not added back to tentative
taxable income when the inventory is sold
and recovered through cost of goods sold
in the 2021 taxable year. Under such facts,
the entire capitalized amount is deemed to
be included in the calculation of the taxpayer’s tentative taxable income for the
2020 taxable year, regardless of the period
in which the capitalized amount is actually recovered. See §§1.163(j)-1(b)(1)(iii)
and 1.163(j)-2(h)(3).
Further, in order to treat similarly situated taxpayers similarly, the final regulations allow taxpayers, and their related
parties within the meaning of sections
267(b) and 707(b)(1), otherwise relying
on the proposed regulations in their entirety under §1.163(j)-1(c) to alternatively choose to follow §1.163(j)-1(b)(1)(iii)
rather than proposed §1.163(j)-1(b)(1)
(iii). See §1.163(j)-1(c).
The Treasury Department and the IRS
note that neither proposed §1.163(j)-1(b)
(1) nor §1.163(j)-1(b)(1) determines the
amount of allowed or allowable depreciation, amortization, or depletion for purposes of any other Code section (for example,
sections 167(c), 1016(a)(2), 1245, and
1250). Accordingly, no inference should
be drawn regarding the determination of
the amount of allowed or allowable depreciation, amortization, or depletion under
any other Code section based on proposed
§1.163(j)-1(b)(1) or §1.163(j)-1(b)(1).
In addition to comments about whether
depreciation, amortization, and depletion
include amounts recovered through cost
of goods sold, a commenter requested
clarification that section 179 deductions
are depreciation deductions for purposes
of section 163(j)(8)(A)(v) and proposed
§1.163(j)-1(b)(1)(i)(D). Section 179 deductions are allowed to be added back as
amortization under proposed §1.163(j)1(b)(1)(i)(E), which allows an addback of
any deduction for the amortization of intangibles (for example, under section 167
or 197) and other amortized expenditures

621

(for example, under section 195(b)(1)(B),
248, or 1245(a)(2)(C)), for taxable years
beginning before January 1, 2022. Section
1245(a)(2)(C) provides “any deduction allowable under sections 179, 179B, 179C,
179D, 179E, 181, 190, 193, or 194 shall
be treated as if it were a deduction allowable for amortization.” Because section
179 deductions are included as amortization under proposed §1.163(j)-1(b)(1)(i)
(E), rather than as depreciation under proposed §1.163(j)-1(b)(1)(i)(D), no clarification is necessary in the final regulations.
See §1.163(j)-1(b)(1)(i)(E).
3. ATI and Floor Plan Financing Interest
Consistent with section 163(j)(8)(A)
(ii), the proposed regulations provide that
any business interest expense or business
interest income is added back to (in the
case of business interest expense) or subtracted from (in the case of business interest income) taxable income in computing
ATI. Because business interest expense
includes floor plan financing interest expense, ATI is further adjusted by subtracting from it any floor plan financing interest expense under proposed §1.163(j)-1(b)
(1)(ii)(B). Floor plan financing interest
expense is also separately included in the
section 163(j) limitation as provided in
section 163(j)(1)(C).
One commenter suggested that floor
plan financing interest expense should
not be subtracted from ATI because such
adjustment is inconsistent with the statute and the ordering implied by section
168(k)(9)(B). The addition of floor plan
financing interest expense as business
interest in the calculation of ATI is consistent with section 163(j)(8)(A)(ii). The
purpose of subtracting floor plan financing interest expense from tentative taxable income to compute ATI is to avoid
the double benefit that would result upon
separately including floor plan financing
interest expense in the computation of
the section 163(j) limitation. If floor plan
financing interest expense were included
in ATI without a corresponding subtraction, thus resulting in an increased ATI,
taxpayers with such expense would be
able to increase their section 163(j) limitation not only by the separately stated
floor plan financing interest under section
163(j)(1)(C), but also by the inclusion of

September 28, 2020

such amount in ATI, which would permit
a deduction of $1.30 (or $1.50, if the 50
percent ATI limitation is applicable) of
business interest expense for each $1 of
floor plan financing interest expense. Although it is clear that Congress did not intend to limit the deduction for floor plan
financing interest expense under section
163(j), there is no indication that Congress also intended to provide the additional benefit of an increased ATI related
to floor plan financing interest expense.
Therefore, under the authority granted in
section 163(j)(8)(B), the final regulations
adopt the proposed rule without change
to include a subtraction of floor plan financing interest expense from tentative
taxable income in computing ATI.
Several commenters also requested
clarification and submitted recommendations on the interaction between section
168(k)(9) and section 163(j). Section
168(k)(9)(B) provides that the additional
first-year depreciation deduction is not allowed for any property used in a trade or
business that has had floor plan financing
indebtedness (as defined in section 163(j)
(9)), if the floor plan financing interest related to such indebtedness was taken into
account under section 163(j)(1)(C).
First, commenters requested that floor
plan financing indebtedness not be treated
as taken into account if the sum of business interest income and 30 percent of
ATI (the sum of section 163(j)(1)(A) and
section 163(j)(1)(B)) is greater than the
business interest expense paid or accrued
in the taxable year. Second, if the sum of
business interest income and 30 percent of
ATI is less than the business interest expense paid or accrued in the taxable year,
commenters requested that taxpayers be
given the option to either include floor
plan financing interest to increase the section 163(j) limitation, or to forgo the use
of floor plan financing interest to increase
the section 163(j) limitation (any forgone
floor plan financing interest would be included in the disallowed business interest
expense carryforward under proposed
§1.163(j)-2(c)) in order to utilize the additional first-year depreciation deduction
under section 168(k).
Section 163(j) does not provide any
guidance on the availability of section
168(k) for taxpayers that have had floor
plan financing interest expense. As these

September 28, 2020

comments relate to the operation of section 168(k)(9), taxpayers should look to
Treasury Department or IRS guidance
provided under section 168(k) for clarification. On September 24, 2019, the Treasury Department and the IRS published
in the Federal Register final regulations
(TD 9874, 84 FR 50108) and proposed
regulations (REG-106808-19, 84 FR
50152) under section 168(k). The rules
regarding when floor plan financing interest expense is “taken into account” for
purposes of 168(k) are in the proposed
regulations under §1.168(k)-2(b)(2)(ii)
(G). Accordingly, these final regulations
do not address the interaction between
section 163(j) and section 168(k)(9) regarding floor plan financing interest expense.
4. Adjustments to Taxable Income in
Computing ATI Under Section 163(j)(8)
(A)
Section 163(j)(8)(A) provides that ATI
means taxable income “computed without regard to” the specified adjustments.
The purpose of the adjustments listed in
section 163(j)(8)(A) is to keep certain
items, such as deductions for depreciation, amortization, depletion, or NOL
carryforward amounts, from directly increasing or decreasing the amount of the
deduction for business interest expense.
Therefore, the Treasury Department and
the IRS have determined that the adjustments listed in section 163(j)(8)(A)
should adjust tentative taxable income
for purposes of calculating ATI under
§1.163(j)-1(b)(1) only to the extent that
they have been reflected (or deemed reflected, as in the case of certain amounts
capitalized into inventory under section
263A as discussed in part II(A)(2) of this
Summary of Comments and Explanation
of Revisions section) in tentative taxable
income under §1.163(j)-1(b)(43).
A commenter requested that the definition of ATI not include some of the adjustments listed in section 163(j)(8)(A), such
as the adjustments for NOL deductions
and deductions under section 199A. The
Treasury Department and the IRS do not
have authority to ignore these clear and
unambiguous statutory adjustments. Thus,
the final regulations do not incorporate the
commenter’s suggestion.

622

5. Certain Adjustments to Tentative
Taxable Income in Computing ATI Under
Section 163(j)(8)(B)
Under the authority granted in section
163(j)(8)(B), the proposed regulations
include several adjustments to taxable income in computing ATI to address certain
sales or other dispositions of depreciable
property, stock of a consolidated group
member, or interests in a partnership. Proposed §1.163(j)-1(b)(1)(ii)(C) provides
that, if property is sold or otherwise disposed of, the lesser of the amount of gain
on the disposition or the amount of depreciation, amortization, or depletion deductions (collectively, depreciation deductions) with respect to the property for the
taxable years beginning after December
31, 2017 and before January 1, 2022 (such
years, the EBITDA period) is subtracted
from taxable income to determine ATI.
Proposed §1.163(j)-1(b)(1)(ii)(D) provides that, with respect to the sale or other
disposition of stock of a member of a consolidated group that includes the selling
member, the investment adjustments (see
§1.1502-32) with respect to such stock that
are attributable to deductions described
in proposed §1.163(j)-1(b)(1)(ii)(C) are
subtracted from taxable income. In turn,
proposed §1.163(j)-1(b)(1)(ii)(E) provides that, with respect to the sale or other
disposition of an interest in a partnership,
the taxpayer’s distributive share of deductions described in proposed §1.163(j)-1(b)
(1)(ii)(C) with respect to property held by
the partnership at the time of such disposition is subtracted from taxable income to
the extent such deductions were allowable
under section 704(d).
In general, when a taxpayer takes depreciation deductions with respect to an
asset, the taxpayer must reduce its adjusted basis in the asset accordingly. As a
result, the taxpayer will realize additional
gain (or less loss) upon the subsequent
disposition of the asset than the taxpayer
would have realized absent depreciation
deductions. Thus, except with regard to
timing (and, in some cases, character), depreciation deductions should have no net
effect on a taxpayer’s taxable income.
In order to mitigate the effects of the
section 163(j) limitation during the EBITDA period, Congress provided an adjustment to taxable income for depreciation

Bulletin No. 2020–40

deductions. More specifically, as discussed in part II(A)(2) of this Summary of
Comments and Explanation of Revisions
section, depreciation deductions are added
back to taxable income during the EBITDA period, thereby increasing a taxpayer’s ATI and its section 163(j) limitation.
Congress intended this adjustment to be a
timing provision that delays the inclusion
of depreciation deductions in calculating a
taxpayer’s section 163(j) limitation. Stated differently, Congress intended to allow
taxpayers to accelerate the recognition of
gain attributable to depreciation deductions when computing ATI.
However, if a taxpayer were to sell
its depreciable property after making the
foregoing adjustment to ATI, the taxpayer would realize additional gain (or less
loss) on the disposition as a result of its
depreciation deductions, and the taxpayer’s ATI would be increased yet again.
Similarly, if the depreciable property were
held by a member of a consolidated group
(S), and if another member of the group
were to sell S’s stock after making negative adjustments to its basis in S’s stock
under §1.1502-32 to reflect S’s depreciation deductions, the consolidated group’s
ATI would be increased yet again. A similar double benefit would arise with respect
to interests in a partnership if, after the
partner’s basis in its partnership interest is
reduced by depreciation deductions associated with the depreciable property, ATI
were to reflect that reduced basis upon a
subsequent sale of the partnership interest.
Proposed §1.163(j)-1(b)(1)(ii)(C), (D),
and (E) were intended to address these situations and ensure that the positive adjustment for depreciation deductions during
the EBITDA period merely defers (rather
than permanently excludes) depreciation
deductions from a taxpayer’s calculation
of the section 163(j) limitation.
Commenters submitted various questions and comments about these provisions. First, a commenter questioned
whether these proposed subtractions from
taxable income are an advisable exercise
of the authority granted in section 163(j)
(8)(B) in light of congressional silence on
the issue. However, the 1991 Proposed
Regulations contained similar subtractions from taxable income in computing
ATI. The 1991 Proposed Regulations had
been outstanding for more than 25 years

Bulletin No. 2020–40

when Congress enacted the TCJA. Thus,
Congress likely was well aware of these
adjustments when it granted the Secretary of the Treasury the authority to make
adjustments in new section 163(j)(8)(B).
Moreover, there is no indication that Congress intended to preclude the Secretary
from making adjustments similar to those
in the 1991 Proposed Regulations.
Second, commenters asked why the
subtraction from taxable income in proposed §1.163(j)-1(b)(1)(ii)(D) does not
include a “lesser of” calculation similar
to proposed §1.163(j)-1(b)(1)(ii)(C), and
they questioned whether the “lesser of”
calculation in proposed §1.163(j)-1(b)(1)
(ii)(C) captures the correct amount. For
example, if a taxpayer purchased property for $100x, fully depreciated the property, and then sold the property for $60x,
should the amount that is backed out under
proposed §1.163(j)-1(b)(1)(ii)(C) be $60x
or $100x? Commenters also stated that
the presence of a “lesser of” limitation in
proposed §1.163(j)-1(b)(1)(ii)(C) and the
absence of such a limitation in proposed
§1.163(j)-1(b)(1)(ii)(D) can yield discontinuities. For example, if S (a member
of P’s consolidated group) uses $50x to
purchase an asset that it fully depreciates
under section 168(k) (resulting in a $50x
reduction in P’s basis in its S stock under
§1.1502-32), and if S sells the depreciated asset for $25x the following year, the
P group would have to subtract $25x from
taxable income under proposed §1.163(j)1(b)(1)(ii)(C), whereas the group would
have had to reduce its taxable income by
$50x under proposed §1.163(j)-1(b)(1)(ii)
(D) if P had sold its S stock instead. Commenters recommended several solutions
to address this discontinuity, including
eliminating the “lesser of” test.
Proposed §1.163(j)-1(b)(1)(ii)(D) does
not include a “lesser of” calculation because such a calculation would require
consolidated groups to value their assets
each time there is a sale of member stock.
However, the Treasury Department and
the IRS recognize the discrepancy in taxable income adjustments between asset
dispositions and member stock dispositions under the proposed regulations. To
eliminate this discrepancy, the final regulations revise proposed §1.163(j)-1(b)
(1)(ii)(C) by eliminating the “lesser of”
standard and requiring taxpayers to back

623

out depreciation deductions that were allowed or allowable during the EBITDA
period with respect to sales or dispositions of property. This revised approach
is consistent with the adjustment for asset
sales in the 1991 Proposed Regulations, is
simpler for taxpayers to administer than
the “lesser of” approach in the proposed
regulations, and renders moot questions
as to whether that “lesser of” calculation
captures the correct amount. However,
the Treasury Department and the IRS also
recognize that, in certain cases, a “lesser
of” computation would not be difficult to
administer. Thus, the Concurrent NPRM
provides taxpayers the option to apply the
“lesser of” standard, so long as they do so
consistently. See proposed §1.163(j)-1(b)
(1)(iv)(E) of the Concurrent NPRM.
Third, commenters asked whether the
application of proposed §1.163(j)-1(b)(1)
(ii)(C) and (D) to the same consolidated
group member would result in an inappropriate double inclusion if the asset
sale precedes the stock sale, and whether
proposed §1.163(j)-1(b)(1)(ii)(C) should
continue to apply to a group member if
the sale of member stock precedes the
asset sale. For example, S (a member of
P’s consolidated group) takes a $50x depreciation deduction in 2020 with respect
to asset X, P’s basis in its S stock is reduced accordingly under §1.1502-32, and
$50x is added back to the P group’s tentative taxable income in computing its 2020
ATI. In 2021, S realizes a $50x gain upon
the sale of asset X, P’s basis in its S stock
is increased accordingly by $50x under
§1.1502-32, and the P group subtracts
$50x from its tentative taxable income
under proposed §1.163(j)-1(b)(1)(ii)(C)
in computing its 2021 ATI. Then, in 2022,
P sells the S stock to an unrelated buyer.
Must P subtract another $50x from its
tentative taxable income under proposed
§1.163(j)-1(b)(1)(ii)(D)? What if the order of sales were reversed (with P selling
its S stock to a member of another consolidated group in 2021 and S selling asset X in 2022)—would both consolidated
groups be required to subtract $50x from
tentative taxable income in computing
ATI? To prevent duplicative adjustments
under proposed §1.163(j)-1(b)(1)(ii)(C)
and (D), commenters recommended that
these rules “turn off” further subtractions
once a subtraction already has been made

September 28, 2020

under either provision, and that the application of proposed §1.163(j)-1(b)(1)(ii)
(C) be limited to the group in which the
depreciation deductions accrued.
The Treasury Department and the IRS
agree that the application of §1.163(j)1(b)(1)(ii)(C) and (D) to the same consolidated group member would result in
an inappropriate double inclusion, and
that proposed §1.163(j)-1(b)(1)(ii)(C)
should not apply to a former group member with respect to depreciation deductions claimed by the member in a former
group. Thus, §1.163(j)-1(b)(1)(iv)(D)
provides anti-duplication rules to ensure
that neither §1.163(j)-1(b)(1)(ii)(C) nor
§1.163(j)-1(b)(1)(ii)(D) applies if a subtraction for the same economic amount
already has been required under either
provision.
For example, assume that P wholly
owns S1, which wholly owns S2, which
owns depreciable asset Q, and that S1
and S2 are members of P’s consolidated
group. Further assume that S2’s depreciation deductions with respect to asset Q
have resulted in investment adjustments
in S1’s stock in S2 and in P’s stock in
S1. If S1 were to sell its S2 stock to a
third party, adjustments to the P group’s
tentative taxable income would be required under proposed §1.163(j)-1(b)(1)
(ii)(D). If P later were to sell its S1 stock
to a third party, an additional adjustment
under proposed §1.163(j)-1(b)(1)(ii)(D)
would not be required with respect to
investment adjustments attributable to
asset Q.
Fourth, commenters observed that
these proposed subtractions from taxable
income in computing ATI are required
even if the disposition of the depreciable
property, member stock, or partnership
interest occurs many years after the EBITDA period. Commenters expressed concern that tracking depreciation deductions
for purposes of these adjustments could
become burdensome, and a commenter
questioned the appropriateness in proposed §1.163(j)-1(b)(1)(ii)(C) of treating
all gain upon the disposition of property
after the EBITDA period as attributable to
depreciation deductions during the EBITDA period.
Commenters are correct in observing
that these proposed adjustments to taxable income in computing ATI must be

September 28, 2020

made even if the relevant depreciable asset, member stock, or partnership interest
is disposed of after the EBITDA period.
However, the Treasury Department and
the IRS note that members of consolidated groups already must track depreciation deductions to calculate separate
taxable income (see §1.1502-12) and to
preserve the location of tax items (see
§1.1502-13). Additionally, all taxpayers
must track depreciation deductions on
an asset-by-asset basis for purposes of
section 1245. Thus, the Treasury Department and the IRS have determined that
the adjustments proposed in §1.163(j)1(b)(1)(ii)(C), (D), and (E) should not
impose a significant administrative burden in many situations. The Treasury
Department and the IRS further note that
eliminating the “lesser of” standard in
proposed §1.163(j)-1(b)(1)(ii)(C) (see
the response to the second comment in
this part of the Summary of Comments
and Explanation of Revisions section)
will render moot the commenter’s concern about the calculation of gain.
Fifth, a commenter asked whether the
term “sale or other disposition” in proposed §1.163(j)-1(b)(1)(ii)(C), (D), and
(E) is intended to apply to the transfer of
stock of a consolidated group member in
an intercompany transaction (within the
meaning of §1.1502-13(b)(1)(i)) or to
the transfer of assets in a nonrecognition
transaction to which section 381 applies (a
section 381 transaction).
As provided in proposed §1.163(j)4(d)(2), a consolidated group has a single
section 163(j) limitation, and intercompany items and corresponding items are
disregarded for purposes of calculating
the group’s ATI to the extent they offset in
amount. The Treasury Department and the
IRS have determined that regarding intercompany items and corresponding items
for purposes of §1.163(j)-1(b)(1)(ii)(C)
and (D) would be inconsistent with this
general approach. Thus, §1.163(j)-1(b)(1)
(iv)(A)(2) provides that an intercompany transaction should not be treated as a
“sale or other disposition” for purposes of
§1.163(j)-1(b)(1)(ii)(C) and (D).
In turn, the transfer of depreciable assets in a section 381 transaction generally
should not be treated as a “sale or other
disposition” because the transfer does not
affect ATI and because the transferee cor-

624

poration is the successor to the transferor
corporation. Thus, the final regulations
generally provide that a transfer of an asset to an acquiring corporation in a transaction to which section 381(a) applies
is not treated as a “sale or other disposition” for purposes of §1.163(j)-1(b)(1)(ii)
(C), (D), and (E). However, if a member
leaves a consolidated group, that transaction generally is treated as a sale or other
disposition under the final regulations for
purposes of §1.163(j)-1(b)(1)(ii)(C) and
(D), regardless of whether the transaction
is a section 381 transaction, because the
adjustment to ATI under these provisions
should be reflected on the tax return of the
group that received the benefit of the earlier increase in ATI.
Sixth, a commenter asked for clarification as to when the adjustment in proposed §1.163(j)-1(b)(1)(ii)(D) is required
and which investment adjustments under
§1.1502-32 are treated as “attributable to”
depreciation deductions for purposes of
this provision. For example, P wholly and
directly owns both S and S1 (members of
P’s consolidated group). In 2021, S purchases asset X for $100x and fully depreciates asset X under section 168(k), and P
reduces its basis in its S stock by $100x
under §1.1502-32. In 2022, P contributes
the stock of S to S1 in an intercompany
transaction (which, as noted previously,
is not treated as a “sale or other disposition” for purposes of proposed §1.163(j)1(b)(1)(ii)(C) and (D)). If P later sells the
S1 stock, is the adjustment in proposed
§1.163(j)-1(b)(1)(ii)(D) required even
though no adjustment to P’s basis in the
S1 stock under §1.1502-32 is “attributable
to” the $100x of depreciation deductions
taken with respect to asset X?
The Treasury Department and the
IRS have determined that the adjustment
to tentative taxable income in proposed
§1.163(j)-1(b)(1)(ii)(D) should apply in
the foregoing situation. The final regulations have been revised to provide that,
for these purposes, P’s stock in S1 would
be treated as a successor asset (within the
meaning of §1.1502-13(j)(1)) to P’s stock
in S.
Seventh, commenters stated that there
should be no adjustments to taxable income under proposed §1.163(j)-1(b)(1)
(ii)(C), (D), and (E) if and to the extent
that adding back depreciation deductions

Bulletin No. 2020–40

pursuant to section 163(j)(8)(A)(v) and
proposed §1.163(j)-1(b)(1)(i) did not increase the amount of business interest
expense the taxpayer could have deducted
in the year the deductions were incurred.
For example, in 2021, corporation C has
$500x of ATI (computed by adding back
$50x of depreciation deductions with respect to asset X) and $100x of business
interest expense. Without adding back the
depreciation deductions, C’s ATI would
have been $450x, C’s section 163(j) limitation would have been $135x ($450x
x 30 percent), and C still could have deducted all $100x of its business interest
expense in that year. In 2022, C has $90x
of business interest expense and $300x of
ATI. C sells asset X for a $50x gain in that
year. If C were required to reduce its ATI
by $50x (from $300x to $250x) in 2022
under proposed §1.163(j)-1(b)(1)(ii)(C),
its section 163(j) limitation would be reduced to $75x ($250x x 30 percent), and
C would not be able to deduct all $90x of
its business interest expense in 2022 even
though C derived no benefit from adding
back its depreciation deductions to taxable
income in 2021.
The Treasury Department and the IRS
have determined that predicating the
application of proposed §1.163(j)-1(b)
(1)(ii)(C), (D), and (E) upon whether a
taxpayer derived a benefit under section
163(j) from adding back its depreciation
deductions to taxable income would involve significant additional complexity.
In addition, this approach would have an
effect similar to allowing a carryforward
of these amounts to the taxable year in
which gain on the related items is recognized on a sale or other disposition.
Such a carryforward is inconsistent with
the general approach of section 163(j),
which does not permit a carryforward
of excess ATI to later taxable years. As
noted earlier in this part II(A)(5) of this
Summary of Comments and Explanation
of Revisions section, depreciation deductions should have no net effect on the
amount of a taxpayer’s taxable income
(except with respect to timing and, perhaps, character). Thus, if a taxpayer sells
an asset with respect to which the taxpayer has taken depreciation deductions,
the increase in gain (or decrease in loss)
upon the sale should be reversed under
proposed §1.163(j)-1(b)(1)(ii)(C).

Bulletin No. 2020–40

6. Adjustments to Adjusted Taxable
Income in Respect of United States
Shareholders of CFCs
Some commenters argued that United
States shareholders, as defined in section
951(b) (U.S. shareholders), of controlled
foreign corporations, as defined in section
957(a) (CFCs), should be allowed to include in their ATI the amounts included in
gross income under section 951(a) (subpart F inclusions), section 951A(a) global intangible low-taxed income (GILTI)
inclusions, and section 78 “gross-up” inclusions (collectively, CFC income inclusions) attributable to non-excepted trades
or businesses. Because section 163(j) applies to CFCs, the Treasury Department
and the IRS have determined that allowing a U.S. shareholder to include its CFC
income inclusions in its ATI would not be
appropriate. The income of the CFC that
gives rise to such income is taken into account in computing the ATI of the CFC for
purposes of determining its section 163(j)
limitation, and allowing the same income
to also be taken into account in computing the ATI of a U.S. shareholder would
result in an inappropriate double-counting
of income.
Furthermore, the Treasury Department
and the IRS question the premise of several comments that, if the business interest
expense of a CFC were excluded from the
application of section 163(j), including the
income of a CFC in a U.S. shareholder’s
ATI would be appropriate. Even if section
163(j) did not apply to CFCs, CFCs are
entities that also may be leveraged. Thus,
permitting the income of the CFC that
gives rise to CFC income inclusions attributable to non-excepted trades or businesses of CFCs to be included in the ATI
of U.S. shareholders would be inconsistent with the principles of section 163(j).
In particular, consider a case in which a
CFC has interest expense of $100x, trade
or business gross income of $300x treated as subpart F income, and no foreign
tax liability. In such a case, a U.S. shareholder that wholly owns the CFC would
have a subpart F inclusion of $200x (if
section 163(j) did not apply to CFCs). If
the $200x subpart F inclusion were included in the ATI of the U.S. shareholder,
the U.S. shareholder could deduct an additional $60x of business interest expense

625

($200x x 30 percent). As a result, $300x
of gross income could support $160x of
interest expense deductions rather than the
$90x permitted under section 163(j)(1).
Finally, under the final regulations (and
consistent with proposed §1.163(j)-7(d)
(1)(ii)), if a domestic partnership includes
amounts in gross income under sections
951(a) and 951A(a) with respect to an
applicable CFC and such amounts are investment income to the partnership, then,
a domestic C corporation partner’s distributive share of such amounts that are properly allocable to a non-excepted trade or
business of the domestic C corporation by
reason of §§1.163(j)-4(b)(3) and 1.163(j)10(c) are excluded from the domestic C
corporation partner’s ATI.
B. Definition of Business Interest
Expense – Proposed §1.163(j)-1(b)(2)
The proposed regulations provide that
business interest expense includes interest
expense allocable to a non-excepted trade
or business, floor plan financing interest
expense, and disallowed business interest
expense carryforwards. The Treasury Department and the IRS received informal
questions about the interaction between
section 163(j) and sections 465 and 469,
which may operate to disallow a deduction for business interest expense even
if such expense was allowable after the
application of section 163(j). More specifically, questions have arisen regarding
how to treat amounts of business interest
expense that are disallowed under section
465 or 469, including which amounts carry forward to subsequent taxable years but
keep their character as interest expense,
and which amounts, if any, are business
interest expense in such subsequent taxable years.
If amounts of business interest expense that are disallowed under section
465 or 469 are treated as business interest expense in subsequent taxable years,
the section 163(j) limitation could operate to disallow a deduction even though
such amounts were allowable in the prior
taxable year after application of the section 163(j) limitation. The Treasury Department and the IRS do not intend such
a result. Therefore, the final regulations
clarify that amounts allowable as a deduction after application of the section 163(j)

September 28, 2020

limitation but disallowed by section 465
or 469 are not business interest expense
subject to the section 163(j) limitation in
subsequent taxable years.
C. Definition of Excepted Regulated
Utility Trade or Business – Proposed
§1.163(j)-1(b)(13)
Numerous comments were submitted
concerning the definition of an “excepted
regulated utility trade or business” under
proposed §1.163(j)-1(b)(13). Proposed
§1.163(j)-1(b)(13), which implements
the exception in section 163(j)(7)(A)(iv)
to the definition of a “trade or business,”
generally provides that an excepted regulated utility trade or business is a trade or
business that sells or furnishes the items
listed in section 163(j)(7)(A)(iv) at rates
that are established or approved by certain
regulatory bodies described in proposed
§1.163(j)-1(b)(13)(i)(B)(1) and (2).
The proposed regulations provide that
utilities that sell or furnish the regulated
items at rates that are established or approved by a regulatory body described in
proposed §1.163(j)-1(b)(13)(i)(B)(1), other than an electric cooperative, are considered to be excepted only to the extent that
such rates are determined on a “cost of
service and rate of return” basis. The “cost
of service and rate of return” requirement
was intended to provide certainty to taxpayers because many utilities are familiar
with the definition of “cost of service and
rate of return,” which is used to determine
whether a public utility company must use
a normalization method of accounting under section 168 for certain properties.
However, several commenters questioned whether a “cost of service and rate
of return” requirement would be satisfied
in specific fact patterns. Commenters
questioned whether certain negotiated
rates are established or approved on a
“cost of service and rate of return” basis
if (1) the applicable regulatory body has
the authority to impose a cost-based rate
instead of the negotiated rate, (2) the rates
are computed with reference to cost but
discounted from the recourse (or maximum) rate allowed by the regulatory body,
or (3) the rates are computed with reference to cost and a set rate of return but
are subject to a market-based cap. Commenters also asked whether the inclusion

September 28, 2020

of certain amounts in determining “cost
of service,” specifically the costs of affiliates and some revenues attributable to
market-rate sales, would affect the determination of whether rates are established
or approved on a “cost of service and rate
of return” basis.
One commenter noted that the normalization rules operate logically only in the
“cost of service and rate of return” context. The commenter stated that, because
section 163(j)(7)(A)(iv) does not reference the normalization rules, there is no
need to include the “cost of service and
rate of return” requirement in the section
163(j) regulations.
The Treasury Department and the IRS
note that, in private letter rulings and informal guidance related to section 168(i)
(9) and (10), the IRS has stated that, for
purposes of applying the normalization
rules, the definition of “public utility property” must contain the requirement that
the regulated rates be established or approved on a “rate of return” basis. In this
guidance, the IRS explained that the normalization method, which must be used
for public utility property to be eligible
for the depreciation allowance available
under section 168, is defined in terms of
the method the taxpayer uses in computing its tax expense in establishing its “cost
of service” for ratemaking purposes and
reflecting operating results in its regulated
books of account. Furthermore, the IRS
has issued numerous private letter rulings
regarding whether under the specific facts
of the taxpayer, the cost of service and
rate of return requirement has been met
for purposes of section 168(i). Thus, it is
clear that, in the context of section 168,
the “cost of service and rate of return” requirement is necessary.
Neither the text of section 163(j) nor
the legislative history specifically references the normalization rules or the “cost
of service and rate of return” requirement
under section 168(i)(10). With the omission of such references, the exception in
section 163(j) for regulated utility trade or
business could be applied broadly without reference to specific requirements
applicable in the normalization rules.
However, the Treasury Department and
the IRS note that under section 168(k)
(9), the additional first-year depreciation
deduction is not available to any proper-

626

ty that is primarily used in an excepted
regulated utility trade or business. Therefore, to ease the administrative burden of
determining whether businesses qualify
as excepted regulated utility trades or
businesses, and to allow taxpayers the
option of claiming the additional firstyear depreciation deduction under section 168(k) in lieu of being treated as an
excepted regulated utility trade or business, the final regulations retain the “cost
of service and rate of return” requirement
from the proposed regulations, and also
allow taxpayers to make an election to
be an excepted regulated utility trade or
business to the extent that the rates for the
furnishing or sale of the items described
in §1.163(j)-1(b)(15)(i)(A)(1) have been
established or approved by a regulatory
body described in §1.163(j)-1(b)(15)(i)
(A)(2), if the rates are not determined on
a “cost of service and rate of return” basis. See §1.163(j)-1(b)(15)(i) and (iii).
For purposes of the election, the focus
of section 163(j)(7)(A)(iv) is the phrase
“established or approved” in section
163(j)(7)(A)(iv), which describes the authority of the regulatory body described
in §1.163(j)-1(b)(15)(i)(A)(2). Ratemaking programs similar to those described
by commenters and discussed previously in this part II(C) of this Summary of
Comments and Explanation of Revisions
section, including discounted rates, negotiated rates, and regulatory rate caps, are
established or approved by a regulatory
body if the taxpayer files a schedule of
such rates with a regulatory body that has
the power to approve, disapprove, alter
the rates, or substitute a rate determined in
an alternate manner.
Similar to elections for electing real
property trades or businesses and electing
farming businesses, the election to be an
excepted regulated utility trade or business is irrevocable. Taxpayers making
the election to be an excepted regulated
utility trade or business are not required
to allocate items between regulated utility
trades or businesses that are described in
§1.163(j)-1(b)(15)(i) and trades or businesses that are described in §1.163(j)1(b)(15)(iii)(A) as to which the taxpayer
makes an election because they are treated
as operating an entirely excepted regulated utility trade or business. Electing taxpayers cannot claim the additional first-

Bulletin No. 2020–40

year depreciation deduction under section
168(k).
The rules set forth in the final regulations are limited solely to the determination of an “excepted regulated utility trade
or business” for purposes of section 163(j)
(7)(A)(iv). As a result of this limited application, the rules in the final regulations
are not applicable to the determination of
“public utility property” or the application of the normalization rules within the
meaning of section 46(f), as in effect on
the day before the date of the enactment of
the Revenue Reconciliation Act of 1990,
section 168(i)(9) and (10) and the regulations thereunder, or to the determination
of any depreciation allowance available
under sections 167 and 168.
Comments also were received on the
application of the rules for excepted regulated utility trades or businesses to electric cooperatives. The definition of an
“excepted regulated utility trade or business” under proposed §1.163(j)-1(b)(13)
includes trades or businesses that sell or
furnish the items listed in section 163(j)
(7)(A)(iv) at rates established or approved
by an electric cooperative. Unlike utility
businesses regulated by public authorities, utilities that sell items at rates regulated by a cooperative are not described
in section 168(i)(10). However, there is a
long-standing body of law regulating the
taxation of electric cooperatives. Electric
cooperatives described in section 501(c)
(12) are generally exempt from income
tax but are subject to taxation under section 511. The application of section 163(j)
and the section 163(j) regulations with
respect to exempt electric cooperatives is
governed by proposed §1.163(j)-4(b)(5).
Other electric cooperatives are subject
to taxation under sections 1381 through
1388 in subchapter T of chapter 1 of subtitle A of the Code (subchapter T), except
for certain rural electric cooperatives specifically excluded from subchapter T by
section 1381(a)(2)(C).
Generally, the exception in section
163(j)(7)(A)(iv) for the trade or business
of selling or furnishing items at rates established or approved by the governing
or ratemaking body of an electric cooperative applies both to sales and furnishing by an electric cooperative and to sales
and furnishing to an electric cooperative
by another utility provider, as long as the

Bulletin No. 2020–40

rates for the sale or furnishing have been
established or approved in the manner required by section 163(j). Thus, an electric
cooperative exempt from Federal income
tax under section 501(c)(12) may not be
subject to section 163(j) for the sale or furnishing of electricity due to the operation
of proposed §1.163(j)-4(b)(5), and another utility provider may be in an excepted
regulated utility trade or business to the
extent that it sells electricity to the section
501(c)(12) cooperative at rates established
or approved by the governing or ratemaking body of the cooperative.
A commenter asked whether proposed
§1.163(j)-1(b)(13) requires that, for sales
involving electric cooperatives to qualify
as an excepted regulated utility trade or
business, the rates for the sales be established or approved by the governing or
ratemaking body of an electric cooperative on a “cost of service and rate of return” basis, or if all sales made subject to
a contract or tariff approved by an electric
cooperative’s governing or ratemaking
body would qualify. Under the proposed
regulations, the specific requirement that
rates for the sale or furnishing of items
listed in proposed §1.163(j)-1(b)(13)
(i)(A) be established or approved on a
“cost of service and rate of return” basis did not extend to rates established or
approved by the governing or ratemaking
body of an electric cooperative. These
regulations adopt the proposed rule, and
do not impose a requirement that rates
for the sale or furnishing of items listed
in §1.163(j)-1(b)(15)(i)(A) by an electric
cooperative be established or approved
on a “cost of service and rate of return”
basis.
Comments also were submitted regarding the allocation of tax items between excepted regulated utility trades or businesses and non-excepted trades or businesses.
These comments are discussed with other
comments on proposed §1.163(j)-10 in
part XI of this Summary of Comments and
Explanation of Revisions section.
D. Definition of Floor Plan Financing
Interest Expense – Proposed §1.163(j)1(b)(17)
Commenters recommended that interest paid on commercial financing liabilities or trade financing (in which a taxpayer

627

borrows to fund the purchase or transport
of commodities and then sells the inventory to pay off the debt) should not be subject to section 163(j). Commenters noted
that trade financing is different from normal financing because it is short-term and
backed by inventory that is monetizable
(rather than plant and equipment). Thus,
commenters suggested that section 163(j)
should not apply to trade financing because there is no depreciation trade-off for
inventory purchased with trade financing.
Commenters compared trade financing
to floor plan financing (because both are
used to finance the purchase of inventory), and they noted that the 1991 Proposed
Regulations under old section 163(j) excluded commercial financing liabilities
from debt taken into account for purposes
of applying the debt-equity ratio under old
section 163(j). See 1991 Proposed Regulations §1.163(j)-3(b)(2)(ii).
The Treasury Department and the IRS
decline to exclude commercial financing
liabilities from the section 163(j) limitation. Section 163(j) does not contain a
provision analogous to the debt-equity ratio safe harbor that was present in old section 163(j) and for which rules were proposed in the 1991 Proposed Regulations.
In addition, because Congress specifically
excluded interest paid on floor plan financing from the section 163(j) limitation, but not all commercial financing liabilities and trade financing, Congress does
not appear to have intended to exclude all
commercial financing liabilities from the
section 163(j) limitation.
E. Definition of Interest – Proposed
§1.163(j)-1(b)(20)
1. In General
Commenters submitted numerous
comments on the definition of “interest”
in the proposed regulations. Proposed
§1.163(j)-1(b)(20) contains a relatively
broad definition of the term “interest” for
purposes of section 163(j). This definition
was proposed to provide a complete definition of interest that addresses all transactions that are commonly understood to
produce interest income and expense, including transactions that otherwise may
have been entered into to avoid the application of section 163(j).

September 28, 2020

Under the proposed regulations, the
term “interest” means any amount described in one of four categories. First,
proposed §1.163(j)-1(b)(20)(i) generally
provides that interest is an amount paid,
received, or accrued as compensation for
the use or forbearance of money under the
terms of an instrument or contractual arrangement, including a series of transactions, that is treated as a debt instrument,
or an amount that is treated as interest under other provisions of the Code or the Income Tax Regulations. For example, this
category includes qualified stated interest,
original issue discount (OID), and accrued
market discount. Commenters agree that
this definition of interest has long been
accepted, is consistent with longstanding
precedent, and reduces the risk of inconsistency within the Code and regulations.
No commenters requested any changes
to this category, and the final regulations
adopt this category in the definition of the
term “interest” without any substantive
changes.
Second, proposed §1.163(j)-1(b)(20)
(ii) treats a swap (other than a cleared
swap) with significant nonperiodic payments as two separate transactions consisting of an on-market, level payment
swap and a loan. Under the proposed regulations, the time value component of the
loan is recognized as interest expense to
the payor and as interest income to the recipient. Several comments were received
on this category in the definition and are
described in part II(E)(2) of this Summary
of Comments and Explanation of Revisions section.
Third, proposed §1.163(j)-1(b)(20)(iii)
treats as interest certain amounts that are
closely related to interest

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Airs%3A2232dd2f962d4a82. Public record. Not legal advice.