Business Interest Deduction Returns to EBITDA in 2025
A significant tax law change taking effect in 2025 restores an EBITDA-based calculation for the business interest deduction, reversing a stricter rule that applied from 2022 through 2024. Enacted as part of the One Big Beautiful Bill Act, the update expands the amount of interest that many businesses can deduct under Section 163(j) of the Internal Revenue Code, reshaping financing decisions as companies continue to face elevated borrowing costs.
Section 163(j) limits how much business interest expense a company may deduct in a given tax year. In most cases, deductible business interest is capped at 30 percent of adjusted taxable income, with any excess carried forward to future years. The rule applies broadly to corporations and many pass-through entities.
From 2018 through 2021, adjusted taxable income was calculated using earnings before interest, taxes, depreciation, and amortization. This EBITDA-based approach enabled the addition of depreciation and amortization, thereby increasing the income base used to determine the interest deduction limitation. That structure generally permitted businesses to deduct more interest in the year it was incurred.
Beginning in 2022, the calculation shifted to an EBIT standard, excluding depreciation and amortization from adjusted taxable income. That scheduled change reduced deduction capacity for many businesses, particularly those with significant capital investments. The impact grew more pronounced as interest rates increased.
Starting with tax years beginning after December 31, 2024, the law permanently restores the EBITDA-based approach. Depreciation and amortization are once again included in adjusted taxable income, raising the 30 percent limitation threshold. This allows more interest expense to be deducted currently, rather than being deferred for future periods.
Under the restored rules, adjusted taxable income generally includes taxable income plus depreciation and amortization adjustments. The limitation percentage itself remains unchanged at 30 percent. Other elements of the calculation continue to follow existing tax law.
The Internal Revenue Service has indicated that current compliance and reporting frameworks remain in place. The change affects how adjusted taxable income is measured, not the mechanics of applying the interest limitation.
The timing of the rule change is particularly significant for businesses that carry debt. Interest rates rose sharply between 2022 and 2024, increasing borrowing costs while the tighter EBIT-based limitation was in effect. Many companies faced higher interest payments without the ability to deduct the full amount for tax purposes.
As a result, disallowed interest accumulated and increased after-tax borrowing costs. For businesses reliant on debt financing, this combination reduced cash flow during a period of tighter credit conditions.
Under the EBIT calculation, businesses refinancing loans at higher rates often exceeded the 30 percent cap more quickly. Disallowed interest could be carried forward, but it did not reduce current-year tax liability. That delay limited the immediate benefit of the interest expense deduction.
Tax analysts say the return to EBITDA reduces that pressure by allowing more interest to be deducted when incurred. This improves liquidity and lowers the effective cost of borrowing.
Industries with significant depreciation, including manufacturing, industrial operations, and real estate development, are among the primary beneficiaries of the change. Depreciation now increases the adjusted taxable income, which in turn raises the ceiling for interest deductions. Businesses with significant fixed assets are therefore more likely to benefit from this approach.
A policy analyst at the Tax Foundation stated that the restoration eliminates a structural disadvantage for investment-intensive businesses. The analyst noted that the change better reflects how long-term assets are typically financed.
The difference between EBIT and EBITDA calculations can materially affect tax outcomes. Under EBIT, depreciation is excluded, which reduces adjusted taxable income and limits deductible interest. This often resulted in interest expense being deferred rather than deducted.
Under the revised EBITDA method, depreciation and amortization are included in the income base used to calculate the 30 percent cap. This allows businesses to deduct more interest upfront, directly reducing current-year tax liability.
Businesses with disallowed interest from 2022 through 2024 may be able to use those carryforwards more quickly under the expanded limitation. The rules themselves have not changed, and unused amounts remain available in future years.
Tax advisers recommend projecting income and interest expense to determine how quickly carryforwards can be absorbed. This analysis can inform decisions regarding refinancing and capital planning.
The modern business interest limitation was introduced under the Tax Cuts and Jobs Act of 2017. Lawmakers aimed to curb excessive leverage while broadening the tax base, while still allowing reasonable interest deductibility. The law established a 30 percent cap, which remains in effect today.
The statute initially relied on an EBITDA-based calculation, with a scheduled transition to EBIT. That transition took effect in 2022 as planned, tightening the limitation during a period of rising interest rates.
During the EBIT period, the United States differed from most peer countries. Research from the Organization for Economic Co-operation and Development shows that EBITDA-based limits are standard internationally. Few countries rely on EBIT to cap interest deductibility.
Policy analysts argued that the EBIT approach put U.S. firms at a competitive disadvantage. The return to EBITDA aligns domestic rules more closely with international standards.
Tax professionals generally welcomed the restoration, citing improved predictability and financing flexibility. Many said the change enables businesses to plan their debt structures and capital expenditures more effectively. Some cautioned that related provisions still require careful review.
“Restoring EBITDA improves cash-flow flexibility, but it does not eliminate the need for careful planning,” said a partner at a national accounting firm.
Beginning in 2026, electively capitalized interest will retain its character as interest expense and remain subject to the limitation. This closes a planning strategy some businesses previously used to reduce exposure to the cap.
Treasury Department officials said the adjustment ensures consistent treatment of interest expense. Advisers recommend reviewing capitalization elections ahead of the 2026 effective date.
By William Mc Lee, Editor-in-Chief & Tax Expert—Get Tax Relief Now
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