There is a line in the tax code that most founders cross without noticing, and it costs them the year they cross it. For 2026 the line is $32 million of average annual sales over the prior three years, counted across every company you control. The IRS restated the number in its August 19 update on the business interest limit, but the same test controls three other things.
Below the line, you can keep your books on a simpler basis, skip capitalizing warehouse and purchasing costs into inventory, and deduct every dollar of interest on your inventory line. Above it, all three switch on in the same year, usually with a one-time bump in taxable income that nobody budgeted.
The direct answer: if your three-year average is anywhere near $32 million, or will be by 2027, find out this quarter which side you are on. The switch is manageable when it is planned and expensive when it is discovered at filing time.
What the line controls
- Accounting method. Below the threshold, a brand that carries inventory can still use the cash method for tax, and can treat inventory under the simplified rules that follow your books or treat it as materials and supplies. Above it, accrual is required, and inventory follows the full rules. IRS Publication 538 lays out both.
- UNICAP. Below the threshold, you are exempt from capitalizing indirect costs into inventory. Above it, a share of warehousing, purchasing, handling, and related overhead has to sit in ending inventory instead of being deducted when paid. For a brand with a big Q4 inventory position, that is a permanent chunk of deductions pushed out a year, and in the crossover year it is a one-time income pickup.
- The interest cap. Below the threshold you deduct all of your business interest. Above it, the deduction is capped at 30% of adjusted taxable income plus interest income. The good news in the August update is that depreciation is added back before the 30% applies for tax years starting after 2024, so a warehouse fit-out no longer shrinks the cap. Anything disallowed carries forward.
How the test actually counts
Three details catch brands off guard.
It is an average of the three prior years, so a brand that did $25 million, $31 million, and $40 million is at $32 million and is over the line for 2026 even though it only had one big year. It also means you can see it coming two years out if anyone is looking.
It aggregates commonly controlled entities. The brand, the holding company, the entity that owns the warehouse, and the sister brand your spouse runs are added together if the ownership overlaps enough. Splitting sales across entities does not keep you under the line.
And the exemption disappears for a tax shelter regardless of size. If your company is not a C corporation and more than 35% of a year's losses go to owners who do not actively work in it, that year you are treated as a tax shelter and lose the small-business exemption from both UNICAP and the interest cap. A $12 million brand with outside investors and one loss year can be caught this way.
What the crossover year costs, as an illustration
Suppose a brand crosses in 2026 with $9 million of inventory on hand at year-end and $700,000 of interest on its lines. Moving from a simplified inventory method to full UNICAP might capitalize, say, 4% of inventory value in indirect costs, about $360,000 of deductions that now wait inside inventory. The change in method comes with a one-time adjustment, which the IRS generally lets you spread over four years, so about $90,000 of extra income a year rather than $360,000 at once. The interest cap only bites if 30% of adjusted taxable income is below $700,000, which for a profitable brand it usually is not, but a brand with a thin year and a big Q4 line can find part of its interest deferred.
None of these numbers are yours. They are the shape of the problem: a method change filed on Form 3115, a spread adjustment, and a cap to model before the Q4 borrowing is signed.
Four things to do before year-end
- Compute the three-year average for 2024 through 2026 across every related entity, using the projected 2026 number. If it lands within 10% of $32 million either way, plan for both outcomes.
- Check the loss-and-investor test for any entity that has posted a loss with passive owners on the cap table.
- If you are crossing, have the method changes prepared with the 2026 return, and put the four-year spread into the tax forecast now so the September and January estimates are right.
- Model the interest cap against every Q4 facility with the depreciation add-back, and keep the disallowed portion, if any, in the after-tax cost of each route.
Where your facts change the answer
The threshold is indexed each year, aggregation turns on ownership details only your records show, and states do not all follow the federal rules on UNICAP or the interest cap. A brand that already keeps accrual books for its lender has less to change than one still on cash. Our earlier guide to modified cash versus accrual covers the book side of that choice.
If nobody has told you which side of $32 million you are on for 2026, that is the tax planning question to ask before the Q4 inventory is financed, because the answer changes what the financing costs.
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.