163 j Aggregation Rules: How to Calculate the Limitation

Section 163(j) of the Internal Revenue Code limits the amount of business interest expense certain taxpayers can deduct each year. This rule, modified by the Tax Cuts and Jobs Act of 2017, requires specific groups of related businesses to be treated as a single entity for this calculation. Instead of each company determining its own interest deduction limit, the group must combine its financial figures to compute one shared limitation. The aggregation requirement is designed to prevent businesses from artificially dividing their operations to avoid the interest limitation.

Determining if Aggregation is Required

A small business exemption is available if a business meets a gross receipts test. For this test, a business must aggregate the gross receipts of all related entities. If the combined group’s average annual gross receipts for the three prior taxable years are below the inflation-adjusted threshold ($31 million for 2025), all members are exempt from the Section 163(j) limitation.

If a group does not qualify for the small business exemption, it must determine if it is a controlled group required to aggregate for the 163(j) calculation. The rules for this are in Internal Revenue Code Sections 52 and 414 and apply to corporations, partnerships, and sole proprietorships. The two primary types of controlled groups are parent-subsidiary and brother-sister groups.

A parent-subsidiary controlled group exists when corporations are connected through stock ownership with a common parent. This structure requires a parent organization to own 80% or more of a subsidiary, measured by either total combined voting power or total value of shares. The group includes the parent and any other corporations where 80% or more is owned by the parent or other group members.

A brother-sister controlled group involves two or more corporations where five or fewer individuals, estates, or trusts have a controlling interest and effective control. This test has two parts. First, the same five or fewer persons must own at least 80% of the voting power or value of shares of each corporation. Second, those same persons must own more than 50% of the voting power or value of each corporation, taking into account only the identical ownership of each person across all corporations.

The aggregation rules also apply to affiliated service groups. These are arrangements where separate organizations work together to provide services. These groups are defined under Section 414 and are treated as a single employer, requiring them to aggregate for the Section 163(j) calculation.

Calculating the Aggregated 163(j) Limitation

Once a group determines it must aggregate, it calculates a single, shared Section 163(j) limitation as if it were one taxpayer by combining financial figures from each member. This final limitation determines the total business interest expense the group can deduct in the current tax year.

First, the group must sum the current-year business interest expense (BIE) from every member. This includes any expense on debt that is properly allocable to a trade or business. This calculation is applied after other Code provisions that might defer, capitalize, or disallow interest expense.

Next, the group must sum the business interest income (BII) from every member. Business interest income is the amount of interest income that is includible in gross income for the year and is allocable to a trade or business.

The third step is to calculate the group’s aggregated adjusted taxable income (ATI) by summing the individual ATI of each member. Each member calculates its own ATI starting with taxable income, but for tax years after January 1, 2022, deductions for depreciation, amortization, and depletion are not added back.

The Section 163(j) limitation is the sum of the group’s total BII, plus 30% of the group’s aggregated ATI. For example, a controlled group consists of Corp A and Corp B. Corp A has $100,000 in BIE, $10,000 in BII, and $400,000 in ATI. Corp B has $50,000 in BIE, $5,000 in BII, and $200,000 in ATI. The group’s aggregated BIE is $150,000, BII is $15,000, and ATI is $600,000. The group’s limitation is $195,000, calculated as $15,000 (BII) + (30% $600,000 ATI). Since the group’s total BIE of $150,000 is less than its $195,000 limitation, the entire amount is deductible.

Allocating the Limitation and Carryforwards

After a controlled group calculates its Section 163(j) limitation, it must allocate that deductible amount among the member entities. This allocation determines how much of its own business interest expense each member can deduct on its separate tax return. The process also dictates what happens to any business interest expense that exceeds the group’s calculated limit.

If the group’s total business interest expense (BIE) is less than or equal to its 163(j) limitation, each member can deduct its full amount of BIE. No further allocation is necessary.

When the group’s total BIE exceeds its limitation, a detailed allocation is required. First, each member with business interest income (BII) can deduct its BIE up to the amount of its BII. Any remaining group limitation is then allocated among members with undeducted BIE on a pro-rata basis, based on each member’s share of the group’s remaining BIE.

Any BIE that a member cannot deduct due to the group’s limitation becomes a disallowed business interest expense carryforward. This carryforward is not held at the group level but is tracked and carried forward by the specific member entity that incurred the expense.

This member-specific carryforward is treated as BIE incurred in the following tax year. It is combined with the member’s current-year BIE and subjected to the group’s limitation calculation in that future year. This allows businesses to potentially deduct the disallowed interest in a year when the group has sufficient deduction capacity.

Special Considerations for Pass-Through Entities

Section 163(j) has unique rules for pass-through entities, such as partnerships and S corporations, involved in an aggregated group. The primary differences from C corporations involve how the limitation is applied and how disallowed interest is handled.

For partnerships, the Section 163(j) limitation is generally applied first at the partnership level. The partnership calculates its own limitation based on its BIE, BII, and ATI. If the partnership has sufficient capacity, it deducts its business interest expense, and the partners are generally unaffected.

When a partnership’s business interest expense exceeds its limitation, the non-deductible portion is known as excess business interest expense (EBIE). The partnership allocates this EBIE to its partners rather than carrying it forward itself. Each partner receives a share of the EBIE and carries it forward on their individual tax returns.

A partner can deduct this EBIE carryforward in a future year only if they are allocated excess taxable income (ETI) or excess business interest income (EBII) from that same partnership. ETI represents the partner’s share of the partnership’s ATI that was not used in the partnership’s 163(j) calculation. A partner’s ability to use these deductions is tied to the future performance of the partnership that generated them.

When a partner is a corporation that is also a member of a controlled group, these rules must be coordinated. The corporate partner’s share of items from the partnership must be included in the controlled group’s overall 163(j) calculation. The EBIE allocated to the corporate partner is treated as its own BIE and is subject to the group’s aggregated limitation. This interaction requires careful tracking of items flowing from the partnership to the corporate partner and into the group’s consolidated calculation.