US TAX DESKWhat the rule does
Interest on business debt used to be fully deductible. Section 163(j), in its current form, limits it: a business can generally deduct business interest only up to 30% of its "adjusted taxable income" (ATI), plus its business interest income.
Interest disallowed in one year is not lost — it generally carries forward indefinitely and can be deducted in a later year when there is more headroom. But a carryforward is worth less than a current deduction, because the cash benefit is deferred.
The entire practical weight of the rule therefore sits on one question: how is adjusted taxable income calculated?
The EBITDA / EBIT distinction
This is the crux, and it is simpler than the acronyms suggest.
- EBITDA-based ATI — earnings measured before subtracting depreciation and amortisation. Because you don't subtract those non-cash charges, ATI is larger, so 30% of it is larger, so more interest is deductible.
- EBIT-based ATI — earnings measured after subtracting depreciation and amortisation. ATI is smaller, the 30% cap is tighter, and less interest is deductible.
A worked illustration makes the gap obvious. Take a business with $100m of operating earnings before depreciation, and $40m of annual depreciation:
| Measure | ATI | 30% cap = deductible interest |
|---|---|---|
| EBITDA basis | $100m | $30m |
| EBIT basis | $60m | $18m |
Same company, same debt, same year — and a $12m difference in deductible interest. For a leveraged business paying, say, $25m of interest, the EBITDA rule allows a full deduction while the EBIT rule disallows $7m of it.
Who this hits hardest
The EBIT measure penalises exactly the businesses with heavy depreciation and heavy debt:
- Real estate — large depreciable asset bases, typically leveraged.
- Infrastructure and energy — long-lived capital assets.
- Manufacturing — significant plant and equipment.
- Private equity portfolio companies — leverage is central to the model.
- Telecoms and data centres — enormous capital expenditure.
Asset-light businesses — software, services, consultancies — have little depreciation, so the two measures produce similar answers and the distinction barely matters to them.
Why the standard has moved
The rule as enacted in 2017 used an EBITDA-style measure for its first several years, then switched to the stricter EBIT measure. That tightening raised the cost of debt financing for capital-intensive businesses, and was among the most lobbied-against provisions in the code. Subsequent legislation restored the more generous EBITDA basis.
The policy argument runs both ways:
For a tighter cap (EBIT): the tax code has long favoured debt over equity, since interest is deductible while dividends are not. That bias encourages leverage, which makes firms more fragile. A stricter limit reduces the distortion and raises revenue.
For a looser cap (EBITDA): depreciation is a non-cash accounting charge; subtracting it before measuring capacity to service debt misrepresents a firm's real economics. Capital-intensive businesses genuinely do generate the cash to pay that interest, and penalising them discourages exactly the long-lived investment policymakers otherwise want to encourage.
Practical points
- The limitation applies at the entity level, with particular complexity for partnerships, where disallowed interest is allocated to partners and carried at their level.
- Small businesses below a gross-receipts threshold are generally exempt.
- Certain real property and farming businesses may elect out, at the cost of using slower depreciation methods — a genuine trade-off, not a free pass.
- Carryforwards make timing matter: a year of weak earnings can push interest into the future even for a normally comfortable borrower.
Related reading
This explainer is analysis and general information, not tax, legal or investment advice.