You are about to sign the line of credit or inventory loan that funds Q4. You assume the interest is a cost of doing business and comes off your taxable income. For most brands it does. For a growing number, the tax code caps how much of it you can deduct in the year you pay it, and the cap changed under last year's tax law.
On August 19 the IRS refreshed its questions and answers on that limit, section 163(j). In plain terms, here is what it says and what to do about it before the facilities close.
Two ways to get caught
Size. If your sales averaged more than $32 million a year over the last three years, the limit applies to you in 2026. Count every company you control together: the brand, the holding company, the entity that owns the warehouse or the 3PL. A brand that crossed the line only last year can still be caught on the three-year average.
Investors and a loss year. This is the one that surprises people. If your company is not a C corporation and more than 35% of a year's losses go to owners who do not work in the business, the tax code calls it a tax shelter for that year, and the small-business exemption disappears regardless of size. A 7-figure brand that raised outside money and posted a loss can lose the exemption on that basis alone.
If neither applies, the rest of this article is a checklist for the year one of them does.
What the cap is
If you are caught, the interest you can deduct this year is capped at 30% of your taxable income before interest, depreciation, and amortization, plus any interest income. Whatever is disallowed is not gone. It carries forward to later years, so the real cost is timing: paying tax now on profit you spent on interest, and getting the deduction later.
The one piece of good news in the update: for tax years starting after 2024, depreciation and amortization are added back before the 30% is applied. Under the previous rules, taking 100% bonus depreciation on a warehouse fit-out shrank your own interest cap in the same year. It no longer does.
As an illustration only: a brand with $3.0 million of profit before depreciation, $1.2 million of depreciation, and $1.0 million of interest. Under the old rules, the cap was 30% of $1.8 million, or $540,000, and $460,000 of interest waited for a later year. Under the restored rules, the cap is 30% of $3.0 million, or $900,000. Same loan, same equipment, $360,000 more deductible this year.
What it does to your real cost of borrowing
Founders compare financing after tax. A 12% line looks like roughly 7.5% once the interest is deducted at a 37% bracket. If the cap disallows part of that interest this year, that part costs you the full 12% until the deduction catches up. That can change which route is cheapest: the bank line, revenue-based financing, supplier terms, or bringing in equity instead. It also changes what your investors see, because in a partnership the disallowed interest is handed to the partners on their K-1s and they can only use it against future income from that same partnership.
If your warehouse sits in its own real estate company, that entity can elect out of the limit, at a price: slower depreciation on the building and no bonus depreciation on the improvements. Worth modeling, not assuming.
Four questions before you sign
- Are we over $32 million on a three-year average, counting every related company?
- Did any of our entities have a loss year with outside investors on the cap table?
- What is our 2026 cap with the depreciation add-back, and does our total interest across every facility exceed it?
- Which of our financing costs count as interest? Revenue-based advances and supplier programs are not always treated the same way, and the answer changes the math.
Ask for last year's Form 8990, the form where this calculation lives. If your preparer has never filed one for you, that is either good news or a gap, and you want to know which. Then put the disallowed portion, if any, into the after-tax cost of each route in your working-capital stack.
Where your facts change the answer
The thresholds move each year. Whether related companies count together, and whether an investor is passive, depends on ownership details only your records show. Some states have not adopted the federal add-back, so a state return can still limit interest the federal return allows. The example above is an illustration, not a projection.
If you borrow to buy inventory and nobody has shown you a Form 8990 with your own numbers on it, that is the tax planning work to finish before the Q4 facilities close.
Reading about taxes usually means paying too much of them.
Over 90% of the time our tax advisors find savings a previous CPA missed — for brands with $150K+ in net profit, a typical first-year plan uncovers $20K–$50K. Grab the free Tax Savings Checklist, browse the tax strategy playbook, or start with a zero-cost planning session.