Virginia: Department of Taxation Issues Guidelines on IRC section 163(j) Limitation

Virginia conforms to the IRC section 163(j) limitations on the deductibility of business interest expense effective for tax years beginning on or after January 1, 2018. However, taxpayers are allowed an annual subtraction equal to 20 percent of the business interest disallowed as a deduction under IRC section 163(j).  The Department of Taxation, after convening a work group to solicit comments on the impact of the limitation for taxpayers filing Virginia consolidated or combined returns, recently issued guidelines addressing these issues. It should be noted that the guidelines are not rules or regulations subject to the Commonwealth’s Administrative Process Act.

The guidelines point out that the 20 percent deduction for business interest expense disallowed under federal law, which accelerates the amount of interest that can be deducted for Virginia purposes as compared to the federal return, will require taxpayers to reconcile this acceleration on their Virginia returns. The Department plans to publish additional guidance on how this should be accomplished in the future.  

Beyond this, the guidelines confirm that separate Virginia filers will need to calculate their 163(j) limitation on a separate entity basis. Taxpayers filing combined returns in Virginia will likewise need to compute the 163(j) limits as if the entities in the combined return filed separate federal returns. If a group is filing a Virginia consolidated return, the 163(j) limitation will be computed on a consolidated basis, but the federal computations will need to be re-computed to reflect the entities included in the Virginia consolidated group, which will likely differ from the federal consolidated group. The guidelines also confirm that if a corporation is subject to certain so-called “fixed-date conformity modifications” (e.g., disallowance of bonus depreciation), it must re-compute its federal taxable income and adjusted taxable income for Virginia purposes before determining its Virginia business interest limitation. Interestingly, the guidelines do not address how the 163(j) limits interact with Virginia’s intangible-related interest addback rules. Please contact Diana Smith at 703-286-8214 with questions on the Guidelines Regarding the Business Interest Limitation.