Adjusted Taxable Income and the Section 163(j) Limitation

Adjusted taxable income under Section 163(j) is the earnings figure that sets your ceiling on business interest deductions. You start with taxable income, remove items that aren’t tied to a trade or business, and add back the deductions the statute tells you to ignore: business interest expense, business interest income, net operating losses, the Section 199A qualified business income deduction, and — for tax years beginning after December 31, 2024 — depreciation, amortization, and depletion. Multiply the result by 30 percent, add your business interest income and any floor plan financing interest, and you have the maximum business interest expense you can deduct this year.¹

How to Calculate Adjusted Taxable Income

The statute defines ATI as taxable income computed without regard to several specific items.¹ Working from a completed taxable income figure, the adjustments run in both directions.

Add back:

Business interest expense you deducted in arriving at taxable income
Any net operating loss deduction
Any Section 199A qualified business income deduction
Depreciation, amortization, and depletion (for tax years beginning after December 31, 2024)

Remove:

Any income, gain, deduction, or loss not properly allocable to a trade or business
Business interest income (it comes back in later as its own line in the deduction cap, not inside ATI)

Capital loss carrybacks and carryovers also require adjustment in the computation.² What you end up with is a broad, cash-flow-oriented earnings measure taken before the code’s special benefits reduce it.

The Return to EBITDA-Style ATI

The depreciation, amortization, and depletion add-back is the change that most affects the size of the number for 2025 and 2026. For tax years 2022 through 2024, the law did not permit those add-backs, so ATI functioned as an EBIT measure and shrank meaningfully for capital-intensive businesses. For tax years beginning after December 31, 2024, the add-backs are restored and the calculation once again resembles EBITDA, matching the approach used from 2018 through 2021.³ A manufacturer with $10 million in depreciation now folds that amount back into ATI, which can unlock a substantial additional deduction.

CFC Inclusions Come Out in 2026

For tax years beginning after December 31, 2025, U.S. shareholders no longer include income from controlled foreign corporations in ATI. Subpart F income, Global Intangible Low-Taxed Income under Section 951A, and the Section 78 gross-up are excluded, along with the associated Sections 245A and 250 deductions.¹ Before this change, those inclusions inflated ATI and effectively created more room for domestic interest deductions. Multinational groups should expect a lower ATI in 2026 and potentially a new or larger carryforward.²

Turning ATI Into Your Deduction Cap

ATI is one of three pieces of the deduction limit. Under Section 163(j), the maximum business interest expense you can deduct in a year equals your business interest income, plus 30 percent of ATI, plus any floor plan financing interest.¹ If your total business interest expense is less than that sum, you deduct all of it. Anything over the cap carries forward.

Business interest income means interest earned in a trade or business — think accounts receivable interest or interest from business lending. Floor plan financing interest is interest on debt used to finance motor vehicles, boats, or farm equipment held for sale or lease, where the inventory secures the loan. Starting with tax years after December 31, 2024, floor plan financing also covers trailers and campers designed for recreational or seasonal use.² Both categories are fully deductible on top of the 30 percent ATI allowance, which softens the limitation for dealerships and equipment sellers relative to other capital-heavy businesses.

When You Don’t Have to Run the Calculation

Two boundaries matter before you spend time computing ATI at all.

First, the small business exemption. A business whose average annual gross receipts for the three prior tax years stay at or below the inflation-adjusted threshold is exempt from Section 163(j) entirely. For tax years beginning in 2026, that threshold is $32 million.⁴ Tax shelters cannot use the exemption regardless of revenue.¹ Splitting a business into pieces to stay under the line does not work: the IRS aggregation rules pool the gross receipts of parent-subsidiary controlled groups, brother-sister controlled groups, and affiliated service groups for this test.⁵ A business sitting near $32 million should watch its rolling average, because crossing the line triggers immediate compliance.

Second, certain trades or businesses can elect out. Real property trades or businesses, farming businesses, and regulated utilities may elect to be excepted from Section 163(j) altogether. Services performed as an employee are excepted by default with no election.² The election is irrevocable and forces the business onto the Alternative Depreciation System for certain property, meaning longer recovery periods and no bonus depreciation.⁶ Residential rental property recovers over 30 years instead of 27.5, nonresidential real property over 40 years instead of 39, and qualified improvement property over 20 years instead of 15. Whether the trade-off makes sense depends on how leveraged the business is against how much it depends on accelerated depreciation.

Consolidated groups run the calculation once at the group level rather than entity by entity, using consolidated business interest expense, business interest income, and consolidated taxable income as the base for ATI.² A profitable subsidiary can effectively supply ATI capacity for a more leveraged sibling.

What Happens to Interest Over the Cap

Interest expense that exceeds the current-year limit is not lost. The statute treats the disallowed amount as business interest paid or accrued in the next tax year, an indefinite rolling carryforward that enters the following year’s calculation alongside that year’s actual interest.¹ If ATI grows or actual interest expense falls, the carryforward gets absorbed. Otherwise it rolls again. For tax years beginning after December 31, 2025, carried-forward interest is not subject to interest capitalization provisions, so those amounts remain available as deductions when finally allowed rather than being pulled into asset basis.²

Partnerships work differently, and this matters if you receive a K-1. A partnership’s disallowed interest is not carried forward at the partnership level. Instead, it is allocated to the partners as “excess business interest expense,” and a partner can only deduct that interest in a future year when the same partnership generates enough excess taxable income or excess business interest income to release it. The partner’s outside basis drops by the allocated amount immediately, even before any deduction is taken. If the partner disposes of the interest before using the suspended amount, a partial basis add-back is made just before the disposition to prevent tax on phantom gain.⁷ S corporations apply the limitation at the entity level but keep carryforwards at the corporate level.¹

Reporting the Calculation on Form 8990

Form 8990, Limitation on Business Interest Expense Under Section 163(j), is where the ATI computation actually gets filed. Any taxpayer with business interest expense, a disallowed interest carryforward, or excess business interest expense from a partnership generally must file it. Small business taxpayers meeting the gross receipts test do not have to file unless they carry excess business interest expense from a partnership.⁸

Part I of the form walks through the calculation of allowable business interest expense and includes a dedicated section for computing ATI.⁹ You enter business interest income, business interest expense, floor plan financing interest, and each ATI adjustment on designated lines. The form computes the 30 percent limit and splits current-year deductions from amounts carried forward. Attach it to Form 1120, 1065, 1120-S, or the applicable individual return. Keep the completed form from every year, because carryforward figures flow directly into the next year’s math and reconstructing them later is difficult.

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. IRS Updates Frequently Asked Questions on Changes to the Limitation on the Deduction for Business Interest Expense
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Internal Revenue Service. Revenue Procedure 2025-32
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Internal Revenue Service. FAQs Regarding the Aggregation Rules Under Section 448(c)(2) that Apply to the Section 163(j) Small Business Exemption
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eCFR. 26 CFR 1.163(j)-9 – Elections for Excepted Trades or Businesses; Safe Harbor for Certain REITs
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eCFR. 26 CFR 1.163(j)-6 – Application of the Section 163(j) Limitation to Partnerships and Subchapter S Corporations
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Internal Revenue Service. Instructions for Form 8990
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Internal Revenue Service. Form 8990 – Limitation on Business Interest Expense Under Section 163(j)