1.163(j)-6: Partnership Business Interest, Excess Allocation, Form 8990

Treasury Regulation 1.163(j)-6 tells partnerships and S corporations how to apply the business interest expense limitation from the Tax Cuts and Jobs Act: the entity runs the 30-percent-of-earnings calculation itself, deducts interest up to that ceiling, and then handles the excess very differently depending on entity type. A partnership pushes the disallowed interest out to its partners as a suspended item locked to that partnership. An S corporation keeps the disallowed amount inside the corporation and carries it forward. Everything else in the regulation is scaffolding around that split.

The Deduction Ceiling

Under IRC 163(j)(1), a business can deduct interest expense in a year only up to the sum of three amounts: its business interest income for the year, 30 percent of its adjusted taxable income, and any floor plan financing interest.¹ Anything above that ceiling is disallowed for the current year. Floor plan financing is zero for most partnerships and S corporations, so the working formula is business interest income plus 30 percent of adjusted taxable income.

Business interest income means interest earned from the entity’s trade or business, not passive investment income. If a partnership earns $200,000 in business interest income and has adjusted taxable income of $1 million, its ceiling for the year is $500,000. Interest up to that amount is fully deductible. What happens to the excess depends on whether the entity is a partnership or an S corporation, and the paths diverge sharply.

Adjusted Taxable Income and Why the Number Keeps Moving

Adjusted taxable income is the denominator that drives how much interest a business can write off. It starts with the entity’s taxable income computed without regard to business interest expense, business interest income, or any net operating loss deduction. For tax years beginning before 2022, depreciation, amortization, and depletion were also added back, which made ATI look like EBITDA. That addback expired for tax years 2022 through 2024, tightening the limitation by pulling ATI closer to EBIT.² Later legislation restored the depreciation and amortization addback for tax years beginning in 2025 and after.

The swing matters in practical terms. A capital-heavy business with $3 million in annual depreciation lost that full amount from its ATI during the 2022–2024 window, shrinking the 30-percent ceiling by nearly a million dollars and trapping interest that would otherwise have been deductible. With the addback back in place, those same businesses have significantly more room.

Who Does Not Have to Run the Calculation

Two categories of business escape the limitation entirely. First, a taxpayer that meets the gross receipts test under IRC 448(c) is exempt, provided it is not a tax shelter.¹ The test averages gross receipts over the three preceding tax years. For tax years beginning in 2025, the threshold is $31 million, adjusted annually for inflation.³ A partnership or S corporation below the line deducts all its business interest without doing the 163(j) math. Aggregation rules can pull a small entity above the threshold once related businesses are counted together.

Second, certain trades or businesses are carved out of the definition entirely, letting them deduct interest without limit:⁴

Real property trades or businesses described in IRC 469(c)(7)(C), including real estate development, construction, leasing, and management, may make a one-time, irrevocable election to be excepted.
Farming businesses as defined in IRC 263A(e)(4) may make the same irrevocable election.
Regulated utilities that furnish or sell electricity, water, sewage disposal, gas, or steam at government-approved rates are automatically excepted with no election required.

The election is not free. Electing real property and electing farming businesses must switch to the alternative depreciation system for certain property, which stretches depreciation over longer recovery periods. Because the election cannot be revoked, a business that elects out while debt is high has no way back once it deleverages.

How Partnerships Allocate the Excess

The interest limitation is calculated at the partnership level, not on partner returns. The partnership computes its business interest expense, business interest income, adjusted taxable income, and any floor plan financing interest, and applies the formula.⁵ The deductible portion reduces the partnership’s nonseparately stated income or loss and flows through normally.

What is distinctive about partnership treatment is what leaves the entity. Instead of carrying the disallowed interest forward at the entity level the way a C corporation does, the partnership allocates three excess items to partners:

Excess business interest expense: interest the partnership could not deduct this year.
Excess taxable income: the portion of ATI not needed to support deductible interest, representing unused capacity the partner can use at their own level.
Excess business interest income: business interest income beyond what the partnership needed for its own deductions.

Treas. Reg. 1.163(j)-6(f)(2) prescribes an eleven-step computation to divide these items among partners.⁵ The elaborate procedure exists because partnership agreements often allocate income and deductions in different ratios, and the regulation matches the disallowed interest to the specific partners whose shares of income or loss generated the limitation. Each partner sees the allocated amounts on their Schedule K-1.

What a Partner Does with Suspended Interest

Excess taxable income and excess business interest income allocated to a partner flow into that partner’s own 163(j) calculation and can help them deduct more interest from other sources. Excess business interest expense is different. It enters a suspended holding pattern locked to the specific partnership that generated it.

A partner can treat suspended excess business interest expense as paid or accrued only in a later year in which the same partnership allocates excess taxable income or excess business interest income to them.⁴ The suspended amount cannot be used against wages, investment income, or income from a different partnership. Even when the originating partnership eventually frees the expense, it enters the partner’s own 163(j) calculation and is deductible only to the extent the partner clears their individual limitation. Clearing the partnership-level trap does not guarantee an immediate deduction.

If the partnership never generates enough excess income to absorb the suspended amount, the expense carries forward indefinitely. That can happen when earnings stay flat while interest costs remain high, leaving partners with suspended deductions and no obvious path to use them short of disposing of the partnership interest.

Basis Effects and Selling the Interest

Excess business interest expense immediately reduces a partner’s outside basis in the partnership, even though the partner cannot yet deduct the expense.⁴ The basis drops now, while the deduction may not come for years, if ever. That timing gap can affect the tax treatment of interim distributions and the gain or loss on a later sale.

When a partner disposes of their entire partnership interest, any remaining suspended excess business interest expense that previously reduced basis is added back to basis immediately before the sale.⁵ The restoration reduces the capital gain or increases the capital loss. The partner permanently loses the right to claim the suspended interest as an ordinary deduction; the benefit converts to a capital account adjustment, which may be taxed at different rates.

Partial dispositions are proportional. The basis increase equals the total undeducted excess business interest expense multiplied by the ratio of the fair market value of the transferred portion to the fair market value of the partner’s total interest.⁵ Suspended expense attributable to the retained portion stays available for future use if the same partnership later allocates enough excess taxable income. Distributions of money or property also count as dispositions for this purpose, which catches partners who might otherwise reduce their interest without triggering the basis restoration.

Loans Between a Partner and the Partnership

A partner who lends money to their own partnership can end up on both sides of a mismatch. The partnership treats the interest it pays as business interest expense, subject to the limitation. The partner reports the interest received as income. Without a special rule, the partner could be allocated excess business interest expense from the partnership while simultaneously reporting taxable interest income from the same loan, with no way to offset one against the other.

Treas. Reg. 1.163(j)-6(n) fixes this with a deemed allocation. When a partner who owns a direct interest in the borrowing partnership is allocated excess business interest expense and also has interest income from a self-charged loan to that partnership, the partner is treated as receiving an allocation of excess business interest income equal to the lesser of the allocated excess business interest expense or the interest income from the loan.⁵ The deemed allocation unlocks a matching amount of suspended interest.

The relief is narrow. It covers only loans from a partner who directly owns an interest in the borrowing partnership. Loans from indirect partners, loans made by a partnership to one of its own partners, and loans from an S corporation shareholder to the S corporation do not qualify.

Why S Corporations Look Different

S corporations run the same formula as partnerships, but the consequence of exceeding the ceiling stays inside the corporation. Disallowed business interest expense carries forward at the entity level to succeeding tax years and is used in a future year to the extent the S corporation generates enough adjusted taxable income and business interest income to support it.²

This makes life simpler for S corporation shareholders. They do not track suspended interest on their personal returns, do not suffer a basis reduction in stock for disallowed interest, and do not deal with basis restoration on sale.⁵ The tradeoff is that the tax benefit is stuck inside the corporation. A shareholder who sells cannot take the carryforward with them; it remains an attribute of the S corporation for its future owners.

For a business expecting persistent interest limitations, this makes entity choice genuinely consequential. A partnership pushes the economics to the partners, who may be able to use excess taxable income from other partnerships or recover value through basis restoration. An S corporation contains everything at the entity but offers shareholders no way to monetize the suspended deduction.

Floor Plan Financing Interest

Floor plan financing interest is added to the deduction ceiling as its own component, so it is effectively deductible without regard to adjusted taxable income.¹ The carve-out primarily benefits motor vehicle dealers and similar businesses that finance inventory with debt secured by that inventory.

The statute defines floor plan financing indebtedness as debt used to acquire motor vehicles held for sale or lease and secured by the acquired inventory. “Motor vehicle” covers any self-propelled vehicle designed for use on public roads, along with boats and farm machinery or equipment.⁴ After 2024, the definition expanded to include trailers and campers designed for recreational or seasonal use that are towed by or attached to a motor vehicle. A dealership carrying $50 million in inventory financed by floor plan loans deducts the full interest outside the 30-percent ceiling.

Form 8990 Filing

Partnerships and S corporations subject to the limitation report the calculation on Form 8990. Entities that qualify as small business taxpayers are generally not required to file, with one important exception: a small business partnership that allocates excess taxable income or excess business interest income to its partners must still file Form 8990 even if the partnership itself has no interest expense.⁶ This catches lower-tier partnerships below the gross receipts threshold that feed excess items into a larger structure.

Even when an otherwise exempt partnership is not required to file, it must provide enough information for any partner who is required to file to complete that partner’s return. In practice, a small partnership that invests in or alongside entities subject to 163(j) needs to maintain the same tracking as a larger entity, whether or not it ever files the form itself.

Tiered Partnerships

The rules layer awkwardly when partnerships own interests in other partnerships. An upper-tier partnership that receives excess business interest expense from a lower-tier partnership must track that suspended amount separately. The excess business interest expense reduces the upper-tier partnership’s basis in its lower-tier interest, and the amount can be freed only when the lower-tier partnership allocates excess taxable income or excess business interest income in a later year. Once freed, the interest expense enters the upper-tier partnership’s own 163(j) calculation and is deductible only to the extent the upper-tier entity clears its own limitation.

Each level applies the limitation independently, so interest that clears the lower-tier ceiling can still be blocked at the upper tier. Partners at the top of a multi-tier structure may hold suspended amounts from several partnerships at different levels, each locked to its own entity and usable only when that entity generates excess income. Errors in this tracking compound quickly and are difficult to unwind in later years.

1
Office of the Law Revision Counsel. 26 USC 163 – Interest
2
Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
3
Internal Revenue Service. Revenue Procedure 2024-40
4
Office of the Law Revision Counsel. 26 US Code 163 – Interest
5
eCFR. 26 CFR 1.163(j)-6 – Application of the Section 163(j) Limitation to Partnerships and Subchapter S Corporations
6
Internal Revenue Service. Instructions for Form 8990 – Limitation on Business Interest Expense Under Section 163(j)