Notice: This guidance was updated on 05/03/2021 to describe required adjustments and reporting procedures in tax years beginning on or after January 1, 2019 and before January 1, 2020, for partnerships and their partners that had business interest expense that was disallowed as a deduction for federal purposes under section 163(j) of the Internal Revenue Code in tax year 2018, but that was allowed as a deduction for Iowa purposes in tax year 2018 because of nonconformity. See Business Interest Expense Deduction for more information about adjustments to the business interest expense deduction required for tax years beginning on or after January 1, 2020.
Beginning in 2018, the deduction for business interest expense is limited for federal purposes under section 163(j) of the Internal Revenue Code. This limitation is calculated and reported on 2018 federal form 8990. Taxpayers are generally allowed to carry forward the disallowed portion of their business expense and deduct these amounts in future years.
Iowa did not conform to this new federal limitation on the business interest expense deduction for tax year 2018. Taxpayers whose business interest expense deduction was limited for federal purposes needed to make certain adjustments to claim the larger Iowa deduction for 2018. For individuals, these adjustments were reported on the IA 1040, line 14, code u. For all other taxpayers, these adjustments were reported on the 2018 Nonconformity Adjustments Worksheet (42-029), line 3.
In the case of partnerships, the entity is not allowed to carry this deduction forward to future tax years for federal purposes. Instead, partnerships reported the excess amount to their partners on the 2018 federal schedule K-1 (Form 1065), Line 13, Code K, and the partners used this amount to make adjustments to the partner’s own interest expense limitation (if any) in future years, following the instructions on the federal forms.
Iowa conformed to the thirty percent federal business interest expense deduction limitation for tax year 2019 only. This means that taxpayers who were subject to the 50% business interest expense deduction limitation for federal purposes may need to make Iowa adjustments to account for the difference. It also means that taxpayers who were allowed to deduct the full amount of interest expense in tax year 2018 may have to make adjustments to account for any federal 2018 carryforward amounts claimed in tax year 2019. These adjustments are described generally in the Department’s guidance on Business Interest Expense Deduction, but special rules relating to partnerships and partners are described below.
No 2018 Iowa nonconformity adjustment by owners of Iowa partnerships or S-corporations* for interest expense deducted by and passed through from an Iowa partnership or S-Corporation should be necessary. The Iowa partnership or S-Corporation should complete the 2018 Nonconformity Adjustments Worksheet (42-029), line 3 to deduct the full interest expense on the entity’s own Iowa return (IA 1065 or IA 1120S), and the reduction to the partner’s or shareholder’s share of the entity’s income will be included in the all source adjustments line of the partner’s or shareholder’s Iowa K-1.
If the partner or shareholder also had business interest expense deductions from other sources that were limited on the partner’s or shareholder’s own federal income tax return as calculated on federal form 8990, the partner or shareholder will also need to make an Iowa nonconformity adjustment to account for that limitation. As noted above, for individuals, these adjustments are reported on the IA 1040, line 14, code u. For all other taxpayers, these adjustments are reported on the 2018 Nonconformity Adjustments Worksheet, line 3. Partners and shareholders should take great care when making these nonconformity adjustments to avoid deducting any business interest expense amount attributable to an Iowa partnership or S-corporation, because those amounts were already deducted on the partner’s or shareholder’s own Iowa return as an all source adjustment from the partner’s or shareholder’s Iowa K-1.
In tax year 2019, a partner will have to make adjustments to their own Iowa interest expense deduction and limitation calculation (if any) to account for amounts the partnership deducted for Iowa purposes but not for federal purposes in 2018. To ensure a partner has the information necessary to make these adjustments, the partnership will be required to report certain information about these 2018 nonconformity adjustments to partners on the 2019 IA 1065 Schedule K-1 (41-018). For a description of the reporting procedures and nonconformity adjustments required of partnerships and partners in tax year 2019, see later in this guidance.
Shareholders in S-Corporations will not have to make similar adjustments in tax year 2019. Due to differences in how disallowed interest expenses are treated for partnerships versus S-Corporations at the federal level, Iowa S-Corporations will make the necessary future year Iowa adjustments at the entity level, without any need for action by the shareholders.
For a description of the nonconformity adjustments required by an Iowa S-Corporation and its shareholders in tax year 2019 resulting from these 2018 federal carryforward amounts, see the Department’s guidance on Business Interest Expense Deduction.
Partnerships and S-Corporations with no Iowa activities likely will not file an Iowa return or issue Iowa K-1’s that account for this larger Iowa deduction in 2018. Generally, owners of passthrough entities will be limited to claiming the deduction actually passed through to them by the entity, without the ability to make any Iowa adjustments. This is because:
the owner’s basis in the entity will be adjusted by the amount of the deduction actually passed through, and
the entity is not required to provide the information to owners that would be necessary to make any Iowa adjustments.
This may result in a lower 2018 deduction for interest from these entities than the owner would have received had the entity filed a 2018 Iowa return, but the owners will be eligible to receive the full deduction amounts in future years when the entity is able to deduct the 2018 disallowed amount as a carryforward. This treatment applies to shareholders of S-Corporations which do not file Iowa returns or issue Iowa K-1s in 2018.
However, because partnerships and their partners report this deduction differently from S-corporations and their shareholders at the federal level, the Iowa treatment for deductions received from a partnership which does not file an Iowa return is also different. At the federal level, the excess business interest expense is allocated to partners in the current year (to be deducted by the partner in future years under certain circumstances) and the partner’s basis in the partnership is adjusted by the amount of excess business interest expense allocated in that year. This excess business interest expense amount is reported to the partners on the 2018 federal K-1 (Form 1065), line 13, code K. Because partners know the exact amount of the 2018 disallowed business interest deduction andbecause their basis in the partnership will be adjusted by that amount in 2018, those partners who receive interest expense deductions from partnerships which do not file Iowa returns, but who do file Iowa returns themselves, may still claim the larger Iowa deduction on business interest expenses actually passed through from the partnership, due to Iowa’s nonconformity for 2018. In order to claim the larger deduction, Iowa partners receiving a federal K-1, but not an Iowa K-1 should include as a business interest expense adjustment on their Iowa return a deduction equal to the amount shown on line 13, Code K of the federal K-1.
Like partners who receive an Iowa K-1, the partner will have to make adjustments in tax year 2019 to the partner’s own interest expense limitation calculation (if any) to account for amounts the partner deducted for Iowa, but not for federal purposes in 2018. These adjustments are described below. Because shareholders in S-Corporations which do not file Iowa returns or issue Iowa K-1s for tax year 2018 cannot make a 2018 Iowa business interest expense deduction adjustment, these shareholders will not be required to make any adjustments in future years, and will instead be allowed the full deduction, including carried forward excess business interest expense amounts in the years in which the S-Corporation actually deducts these amounts.
Iowa taxpayers are not allowed to deduct business interest expense amounts that represent federal carryforward amounts from tax year 2018 and that were already allowed as an Iowa deduction in tax year 2018. This requires special reporting and calculations by partnerships and partners because of the manner in which they account for federal carryforward amounts. While the partnership may have been allowed an Iowa deduction in tax year 2018 for the federally-disallowed interest expense amounts, the partner will be the taxpayer ultimately deducting those federal carryforward amounts in future tax years. Thus, partners will be required to add back federal carryforward amounts from tax year 2018 that were allowed as an Iowa deduction in tax year 2018 to the partner or to the Iowa partnership that had a 2018 filing requirement.
Iowa partnership reporting requirement: To facilitate the proper calculation of this partner add-back, Iowa partnerships that had a 2018 Iowa filing requirement will be required to report to each partner in tax year 2019 that partner’s share of the 2018 business interest expense that was disallowed for federal purposes, but which the partnership was allowed to deduct on the partnership’s 2018 Iowa Nonconformity Adjustments Worksheet, line 3. These amounts are reported on new line 17 of the 2019 IA 1065 Schedule K-1. The amount reported to a partner should match the amount entered on that partner’s federal 2018 Schedule K-1 (Form 1065), Box 13, Code K. If a partner in an Iowa partnership received a 2018 IA 1065 Schedule K-1 but does not receive a 2019 IA 1065 Schedule K-1, the partner should contact that partnership and request information on the partner’s share of the partnership’s 2018 business interest expense adjustment, if any, that would have been included on the 2019 IA 1065, Schedule K-1, line 17.
Partner carryforward adjustment: For tax years beginning on or after January 1, 2019, partners will use the sum of any amounts reported to them by an Iowa partnership in 2019, as described above, and any other business interest expense nonconformity adjustment made on the partner’s own 2018 Iowa tax return (except such adjustments that were made by partners that are themselves a partnership) to compute their 2018 Iowa carryforward adjustment that is required as an add back in tax year 2019 or later. This 2018 Iowa carryforward adjustment is calculated and reported using Part I of the IA 101 Nonconformity Adjustments (42-029) form. A partner may not be allowed to deduct their entire federal carryforward amount from 2018 in a single tax year, so the partner may need to add back the 2018 Iowa carryforward adjustment over several tax years.
What does this mean?
Iowa has not conformed to the federal interest expense limitations for 2018, meaning the 2018 Iowa deduction may be larger than the federal deduction, but Iowa adjustments may be required.
Iowa does conform to the federal interest expense limitation for 2019. Generally, taxpayers’ interest expense limitations will be the same for Iowa and federal purposes for these years, but taxpayers who made adjustments to the Iowa deduction in 2018 due to nonconformity may have to make adjustments for carryforward in 2019.
Special reporting requirements may apply to entities that file as partnerships or S-Corporations and to their partners or shareholders.
* For purposes of this guidance, an “Iowa” partnership or S-Corporation is any partnership or S-Corporation that files or is required to file an Iowa return and issue Iowa K-1s for a given tax year.
