United States

Evaluation of the realizability of a Section 163(j) carryforward


The Tax Cuts and Jobs Act limited the deductibility of interest expense under Internal Revenue Code section 163(j). In December 2019, the American Institute of Certified Public Accountants issued Q&A Section 3300, Deferred Taxes, which addresses how an entity should evaluate the realizability of its existing deferred tax assets (DTAs) related to disallowed interest deductions when an entity expects to generate future disallowed interest deductions, there are reversing deferred tax liabilities (DTLs) and an expectation of future interest expense that also will be limited under Section 163(j).

Per the Q&A, realization of DTAs depends on the existence of sufficient taxable income of the appropriate character within the carryback and carryforward period available under the tax law. There are four sources of taxable income that companies may consider as support for the realization of DTAs:

  • Taxable income in prior carryback year(s) if carryback is permitted under the tax law
  • Future reversals of existing taxable temporary differences
  • Tax planning strategies 
  • Future taxable income exclusive of reversing temporary differences and carryforwards

Entities should consider each source of income incrementally to determine the amount of the valuation allowance needed, if any. To the extent one or more sources of taxable income is sufficient to support a conclusion that a valuation allowance is not necessary, other sources need not be considered. In situations where a valuation allowance is required, consideration of each source is required to determine the amount of the valuation allowance that is recognized for deferred tax assets.

When applying the preceding guidance to evaluate the realizability of DTAs related to disallowed interest carryforwards under Section 163(j), an entity should not recognize a valuation allowance if the taxable income to be generated upon reversal of its existing DTLs (ignoring future income or loss and future interest expense included in future income or loss) is sufficient to realize those DTAs, after considering reversal patterns and the general limitation of business interest expense to 30 percent of adjusted taxable income under Section 163(j). Whether an entity will continue to be in an interest limitation position each year in the future (resulting in an inability to use the Section 163(j) carryforward) is not relevant if the reversal of existing taxable temporary differences is sufficient to support realization of existing DTAs. Rather, if one source of future taxable income (the second source mentioned previously) exists, and that source is believed to be sufficient, then no other sources of future taxable income need to be evaluated.

If the reversal of existing taxable temporary differences is not sufficient to realize existing DTAs, additional sources of taxable income would be considered. In these situations, future limitations would be relevant and need to be considered in the projections and in assessing the realizability of any remaining

DTAs, whether related to Section 163(j) or otherwise. Future income projections may represent an incremental source of taxable income for purposes of realizing those DTAs but would not affect the assessment of DTAs already deemed realizable as a result of the reversal of existing taxable temporary differences.

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