Reg. § 1.381(c)(20)-1 Carryforward of disallowed business interest.
(a) Carryover requirement Section provides that the acquiring corporation in a transaction described in section will succeed to and take into account the carryover of disallowed business interest described in section to taxable years ending after the date of distribution or transfer.
(b) Carryover of disallowed business interest described in section 163(j)(2) For purposes of section and this section, the term carryover of disallowed business interest described in section means the disallowed business interest expense carryforward (as defined in ), including any disallowed disqualified interest (as defined in ), and including the distributor or transferor corporation's disallowed business interest expense from the taxable year that ends on the date of distribution or transfer. For the application of section to disallowed business interest expense described in section , see the regulations in this part under section 382 of the Code, including but not limited to .
(c) Limitation on use of disallowed business interest expense carryforwards in the acquiring corporation's first taxable year ending after the date of distribution or transfer
(1) In general In determining the extent to which the acquiring corporation may use disallowed business interest expense carryforwards in its first taxable year ending after the date of distribution or transfer, the principles of and apply with appropriate adjustments, including but not limited to the adjustments described in and of this section.
(2) One date of distribution or transfer within the acquiring corporation's taxable year If the acquiring corporation succeeds to the disallowed business interest expense carryforwards of one or more distributor or transferor corporations on a single date of distribution or transfer within one taxable year of the acquiring corporation, then, for the acquiring corporation's first taxable year ending after the date of distribution or transfer, that part of the acquiring corporation's business interest expense deduction (if any) that is attributable to the disallowed business interest expense carryforwards of the distributor or transferor corporation is limited under this to an amount equal to the post-acquisition portion of the acquiring corporation's section limitation, as defined in of this section.
(3) Two or more dates of distribution or transfer in the taxable year If the acquiring corporation succeeds to the disallowed business interest expense carryforwards of two or more distributor or transferor corporations on two or more dates of distribution or transfer within one taxable year of the acquiring corporation, the limitation to be applied under this is determined by applying the principles of to the post-acquisition portion of the acquiring corporation's section limitation, as defined in of this section.
(4) Definition For purposes of this , the term post-acquisition portion of the acquiring corporation's section limitation means the amount that bears the same ratio to the acquiring corporation's section limitation (within the meaning of ) (or, if the acquiring corporation is a member of a consolidated group, the consolidated group's section limitation) for the first taxable year ending after the date of distribution or transfer (taking into account items to which the acquiring corporation succeeds under section , other than disallowed business interest expense carryforwards) as the number of days in that year after the date of distribution or transfer bears to the total number of days in that year.
(5) Examples For purposes of this , unless otherwise stated, X, Y, and Z are taxable domestic C corporations that were incorporated on January 1, 2021 and that file their tax returns on a calendar-year basis; none of X, Y, or Z is a member of a consolidated group; the small business exemption in does not apply; interest expense is deductible except to the extent of the potential application of section ; and the facts set forth the only corporate activity. The principles of this are illustrated by the following examples.
(i) Example 1: Transfer before last day of acquiring corporation's taxable year
(A) Facts On October 31, 2022, X transferred all of its assets to Y in a statutory merger to which section applies. For the 2021 taxable year, X had $400x of disallowed business interest expense, and Y had $0 of disallowed business interest expense. For the taxable year ending October 31, 2022, X had an additional $350x of disallowed business interest expense (X did not deduct any of its 2021 carryforwards in its 2022 taxable year). For the taxable year ending December 31, 2022, Y had business interest expense of $100x, business interest income of $200x, and ATI of $1,000x. Y's section limitation for the 2022 taxable year was $500x ($200x + (30 percent × $1,000x) = $500x).
(B) Analysis Pursuant to , Y deducts its $100x of current-year business interest expense (as defined in ) before any disallowed business interest expense carryforwards (including X's carryforwards) from a prior taxable year are deducted. The aggregate disallowed business interest expense of X carried forward under section to Y's taxable year ending December 31, 2022, is $750x. However, pursuant to of this section, for Y's first taxable year ending after the date of distribution or transfer, the maximum amount of X's disallowed business interest expense carryforwards that Y can deduct is equal to the post-acquisition portion of Y's section limitation. Pursuant to of this section, the post-acquisition portion of Y's section limitation means Y's section limitation times the ratio of the number of days in the taxable year after the date of distribution or transfer to the total number of days in that year. Therefore, only $84x of the aggregate amount ($500x × (61/365) = $84x) may be deducted by Y in that year, and the remaining $666x ($750x−$84x = $666x) is carried forward to the succeeding taxable year.
(C) Transfer on last day of acquiring corporation's taxable year The facts are the same as in of this section, except that X's transfer of its assets to Y occurred on December 31, 2022. For the taxable year ending December 31, 2022, X had an additional $350x of disallowed business interest expense (X did not deduct any of its 2021 carryforwards in its 2022 taxable year). For the taxable year ending December 31, 2023, Y had business interest expense of $100x, business interest income of $200x, and ATI of $1,000x. Y's section limitation for the 2023 taxable year was $500x ($200x + (30 percent × $1,000x) = $500x). The aggregate disallowed business interest expense of X carried under section to Y's taxable year ending December 31, 2023, is $750x. of this section does not limit the amount of X's disallowed business interest expense carryforwards that may be deducted by Y in the 2023 taxable year. Since the amount of Y's section limit for the 2023 taxable year was $500x, Y may deduct the full amount ($100x) of its own business interest expense for the 2023 taxable year, along with $400x of X's disallowed business interest expense carryforwards.
(ii) Example 2: Multiple transferors on same date
(A) Facts On October 31, 2022, X and Y transferred all of their assets to Z in statutory mergers to which section applies. For the 2021 taxable year, X had $300x of disallowed business interest expense, Y had $200x, and Z had $0. For the taxable year ending October 31, 2022, each of X and Y had an additional $125x of disallowed business interest expense (neither X nor Y deducted any of its 2021 carryforwards in 2022). For the taxable year ending December 31, 2022, Z had business interest expense of $100x, business interest income of $200x, and ATI of $1,000x. Z's section limitation for the 2022 taxable year was $500x ($200x + (30 percent × $1,000x) = $500x).
(B) Analysis The aggregate disallowed business interest expense of X and Y carried under section to Z's taxable year ending December 31, 2022, is $750x. However, pursuant to of this section, only $84x of the aggregate amount ($500x × (61/365) = $84x) may be deducted by Z in that year. Moreover, under of this section, this amount only may be deducted by Z in that year after Z has deducted its $100x of current-year business interest expense (as defined in ).
(d) Applicability date This section applies to taxable years beginning on or after November 13, 2020. However, taxpayers and their related parties, within the meaning of sections and , may choose to apply the rules of this section to ta axable year beginning after December 31, 2017, so long as the taxpayers and their related parties consistently apply the rules of the section regulations (as defined in ), and, if applicable, , , , , , , , , , , , , , , , , , , , , through (to the extent they effectuate the rules of , , , and ), and 1.1504-4, to that taxable year.
[T.D. 9905, 85 FR 56832, Sept. 14, 2020]