Iowa’s conformity with the federal limitations on business interest expense deductions imposed by Internal Revenue Code (IRC) section 163(j) varies depending on the year. For tax years beginning on or after January 1, 2019, and before January 1, 2020, Iowa conformed with the federal limitation. At this time Iowa does not conform to the federal limitation for tax years beginning on or after January 1, 2020. Due to these differences in conformity, some taxpayers will need to make certain adjustments to their federal business interest expense deduction to calculate the correct Iowa deduction amount for a given year.
Business Interest Expense Conformity for Tax Year 2019 and Later
Conformity for 2019
For tax years beginning on or after January 1, 2019 and before January 1, 2020 (TY 2019) Iowa conforms with the business interest expense deduction limitations imposed by Internal Revenue Code (IRC) section 163(j), without regard to the increased limitations allowed by section 2306 of the Coronavirus Aid Relief and Economic Security (CARES) Act. Specifically, this means that the adjusted taxable income (ATI) percentage limitation is 30% for Iowa tax purposes in TY 2019, not the 50% ATI limitation allowed for federal purposes under the CARES Act. A taxpayer (other than a partnership) who did not elect out of this increased ATI percentage provided in the CARES Act must recompute their 2019 federal business interest limitation for Iowa tax purposes using 30% of ATI instead of 50% of ATI. See Iowa Nonconformity: Coronavirus Aid, Relief, and Economic Security (CARES) Act of 2020 for more information about how to adjust for Iowa nonconformity with the CARES Act for TY 2019.
Iowa Treatment of 2018 Carryforward Amounts in 2019
Iowa taxpayers are not allowed to deduct business interest expense amounts that represent federal carryforward amounts from TY 2018. For TY 2019, taxpayers whose business interest expense deduction was limited for federal, but not for Iowa, purposes in TY 2018 are required to add back any federal carryforward amounts from TY 2018 on the taxpayer’s 2019 Iowa return to the extent those amounts are actually deducted on the taxpayer’s 2019 federal return. These and other carryforward adjustments resulting from 2018 nonconformity are calculated and reported using the IA 101 Nonconformity Adjustments form, Part I. Taxpayers may not be allowed to deduct the entire federal 2018 interest expense carryforward amount in 2019. Interest expense carryforward amounts not actually deducted on a taxpayer’s 2019 federal return will be added back on Iowa returns in future years (see below).
Special rules for reporting the disallowed business interest expense deduction carryforward apply to partnerships and their partners, both for TY 2018 and for TY 2019. See the Department’s Partnership Interest Expense Nonconformity Adjustment guidance for more information.
Iowa does not conform with the federal limitations on the business interest expense deduction for any year other than TY 2019. As a result, taxpayers who have their current-year business interest expense deduction limited for federal purposes in any year other than TY 2019 (see above), are allowed a larger Iowa deduction that year.
In TY 2018 this larger deduction was claimed as a nonconformity adjustment on the IA 1040, line 14, code “u”, for individuals, or on the 2018 Nonconformity Adjustments Worksheet, line 3, for all other taxpayers.
For tax years beginning on or after January 1, 2020, adjustments for Iowa’s nonconformity with IRC section 163(j) are made on IA 163 (all years) and IA 163A (special adjustment available in 2020 only) and are reported as indicated on the chart below for the various tax types. Adjustments for Iowa’s nonconformity with IRC section 163(j) may be either positive or negative for a given year, depending on whether the taxpayer had their current-year interest expense deduction limited or was allowed to deduct prior year carryforward on that year’s federal return (see below).
Iowa Form: Enter additions to income
from line 6 on:
Enter reductions to income
from line 6 on:
1040 Other income, line 14, code y Other income, line 14, code y 1041 Other income, line 8 Other income, line 8 1065 Part III, line 3 Part III, line 6 1120 Schedule A, line 16 Schedule A, line 16 1120S Part III, line 3 Part III, line 7 1120F Schedule A, line 6 Schedule D, line 7
Prior-year Disallowed Amounts (2020 only)
Due to Iowa’s conformity with the 30% limitation on business interest expense deductions for TY 2019 some taxpayers may have had a disallowed business interest expense deduction from 2019 to carryforward and deduct for Iowa purposes in future years. Because Iowa does not conform to the federal interest expense deduction limitations for tax years beginning on or after January 1, 2020, these 2019 Iowa carryforward amounts are all deductible for Iowa purposes in 2020 regardless of whether they were deductible for federal purposes in 2020. The amount of this 2020 deduction of 2019 Iowa carryforward amounts is calculated for all tax types using IA 163A Interest Expense Carryforward Adjustments and reported on tax type-specific forms according to the instructions provided with the IA 163A. This deduction for Iowa carryforward amounts from 2019 is a one-time catch up adjustment, meaning this adjustment, and the IA 163A, are available only on the taxpayer’s 2020 Iowa return.
Prior-year Carryforward Amounts (All Tax Types)
While IRC section 163(j) does limit the current business interest expense deduction, it also allows taxpayers to carry forward the disallowed amounts and deduct them in future years. This means that in TY 2019 and future tax years, taxpayers may be allowed a federal carryforward deduction for business interest expense amounts which were disallowed for federal purposes in a prior year, but which taxpayers were allowed to deduct for Iowa purposes in that prior year.
Iowa taxpayers are not allowed to deduct business interest expense amounts that represent federal carryforward amounts from a prior year. For tax years beginning on or after January 1, 2019, taxpayers whose business interest expense deduction was limited for federal, but not for Iowa, purposes in a prior year are required to add back any federal carryforward amounts from prior years on the taxpayer’s Iowa return in the year those amounts are actually deducted for federal purposes.
Partnerships and S-corporations
For tax years beginning on or after January 1, 2020, partnerships and S-corporations that are subject to the business interest expense deduction limitation at the federal level and that file an Iowa return (Iowa partnerships or Iowa S-corporations) will be able to deduct all current year business interest expense without regard to the limitation at the entity level for Iowa purposes. This additional current year Iowa deduction will be reflected in the all source adjustment on the partners’ or shareholders’ Iowa K-1s, and will not appear as a separately stated item.
Current-year Adjustments for Partners and Shareholders
Partners and shareholders of Iowa partnerships or S-corporations are not permitted to make adjustments for the amount of federal disallowed business interest expense allocated from an Iowa partnership or S-corporation because those amounts are already included in the partners’ or shareholders’ all source adjustments as described above.
Partners in partnerships that do not file Iowa returns (non-Iowa partnerships) may include as part of their own Iowa business interest expense deduction the total amount of current year excess business interest expense deduction passed through to them from all non-Iowa partnerships as shown on the federal Schedule K-1 (Form 1065), line 13, code K. These amounts are reported on the IA 163 Schedule A.
Due to the difference in the way partnerships and S-corporations report interest expense deduction carryforwards at the federal level, Iowa shareholders in S-corporations that do not file Iowa returns (non-Iowa S-corporations) will be limited to the allowable current year federal interest expense deduction amount passed through from the non-Iowa S-corporation, but these shareholders will be eligible to receive the full deduction amounts in future years when the entity is able to deduct the prior-year disallowed amounts as a carryforward for federal purposes without being required to add these carryforward amounts back for Iowa purposes.
Corporate Consolidated Groups
Iowa law generally requires each corporation doing business in Iowa to file its own separate Iowa income tax return. Affiliated groups of corporations which file a consolidated federal return are permitted to file a single Iowa consolidated return that includes all members of the affiliated group that are subject to Iowa corporate income tax. Once an affiliated group has elected to file a consolidated Iowa return, the group is required to continue filing consolidated Iowa returns for all future years unless certain criteria are met.
This means that when a corporation subject to Iowa income tax is included on a federal consolidated return and either;
- Files its own separate Iowa return, or
- Is included on a consolidated Iowa return that does not include all of the same members as the federal consolidated return, because not all members of the federal group are subject to Iowa corporate income taxes (Iowa consolidated group),
the separate Iowa return filer or Iowa consolidated group is required to recalculate their proper current-year business interest expense deduction, and the amount of any prior year disallowed business interest expense carryforward which must be added back for Iowa purposes, for the separate entity or Iowa consolidated group by re-completing for Iowa purposes (pro forma) the federal interest expense deduction forms for the separate entity or Iowa consolidated group. The pro forma deduction amount calculated for Iowa purposes is determined in the same manner as the deduction would be calculated for federal purposes, but using only the items of income and interest expense of the separate Iowa entity or Iowa consolidated group. The deduction and prior year carryforward adjustments from this pro forma federal calculation are then used to complete the IA 163 and make the proper Iowa adjustments.
In the event that a member leaves the consolidated group, both the newly separated member and the remaining group shall be required to include any carryforward amounts allocated to them under Treas. Reg. 1.163(j)-5(b)(3)(iii) in their respective Iowa incomes in the year or years the separate company or group actually deducts those amounts for federal purposes.
A consolidated group is not permitted to deduct any disallowed business interest expense carryforward amount of a member arising in a separate return limitation year (SRLY) for Iowa purposes, and must add back such amounts on the Iowa return in the same year in which the consolidated group is permitted to deduct the SRLY carryforward amount for federal purposes. See 26 Treas. Reg. 1.163(j)-5(d) for more information about the federal treatment of these carryforward amounts.