The 2017 Tax Cuts and Jobs Act (TCJA) contained revisions to the former “earnings stripping” provisions under section 163(j), resulting in a new layer of reporting/compliance that may affect IC-DISC taxpayers. Prior to the TCJA, the earnings stripping rules restricted a corporation’s payment of deductible interest to a related party who paid no U.S. tax on that corresponding income. Under the new law, business interest expense is simply limited to the entity’s business interest income for the year plus 30% of its adjusted taxable income for that year.
While this is certainly a more straightforward calculation, its rationale is puzzling. Now the related-party angle triggering the old earnings stripping provisions has been eliminated, why does the IRS penalize me for paying my bank as much interest as I may need/want?
What does this have to do with an IC-DISC? In a perfect world, nothing, as an IC-DISC should never be in a situation that would obligate it to pay an interest expense (there is no plausible reason for an IC-DISC to incur interest-bearing debt.) However, the tests required to determine if an entity is exempt from the new interest expense limitation rule are performed on a controlled-group basis. Therefore, any IC-DISC that is part of a controlled group with average revenues exceeding $25 million over the last three years must comply with the new reporting requirement.
The new Form 1120-IC-DISC drafted for the 2018 filing season brings this issue to the fore as it adds “Question 8” to Schedule O, Other Information. This new, lengthy question (actually a collection of sub-questions and tests) requires the taxpayer to specifically address its qualification for exemption from the interest limitation rules. If one of the exemptions apply, no further action is necessary after answering Question 8 with a “Yes.”
Non-exemption, signified by answering “No,” requires the completion and attachment of Form 8990, Limitation on Business Interest Expense Under Section 163(j). This new, two-page form (the third page should prove entirely irrelevant for an IC-DISC) will report zero interest expense coming from the IC-DISC and will simply restate its commission income.
In conclusion, an issue that should be of no relevance to an IC-DISC – excess business interest incurred – becomes a subject that requires specific analysis every year, with the potential need for additional reporting and attachment of Form 8990. Don’t let this one surprise you when complying with tax reporting requirements starting in 2018.