The Pennsylvania Department of Revenue (DOR) issued Corporation Tax Bulletin 2026-01 which provides guidance on the Pennsylvania corporate net income tax (CNIT) and personal income tax (PIT) treatment of the federal limitation on business interest expense under IRC Section 163(j). The bulletin, issued Sept. 10, 2026, is effective for tax years beginning on or after Jan. 1, 2025.
CNIT Decoupling from IRC Section 163(j) Amendments
The federal One Big Beautiful Bill Act (OBBBA – P.L. 119-21) amended the calculation of the IRC Section 163(j) limitation for tax years beginning after 2024. However, Pennsylvania Act 45 of 2025 decoupled from those amendments. Under Act 45, the decoupling is not treated as a modification of federal taxable income but requires a CNIT taxpayer to recompute its federal taxable income using IRC Section 163(j) in effect on Dec. 31, 2024. In recomputing its federal taxable income, a corporate taxpayer should take into account other adjustments resulting from the decoupling, e.g., its deduction for charitable contributions.
Computation of IRC Section 163(j) Limitation on a Separate Company Basis
In a change from Corporation Tax Bulletin 2019-03, Pennsylvania Corporate Net Income Tax Treatment of IRC Section 163(j) (Issued April 29, 2019; revised Oct. 12, 2023; revised July 30, 2026 – Effective for tax years beginning before Jan. 1, 2025), all corporate taxpayers, including those that are members of a federal consolidated return, now will need to determine the applicability and amount of IRC Section 163(j) limitation on a separate company basis. For tax years beginning prior to Jan. 1, 2025, a member of a consolidated return group did not have to perform a separate Pennsylvania IRC Section 163(j) analysis unless the federal consolidated group reported a limitation on its consolidated Form 1120. Under that policy, if there was not an IRC Section 163(j) limitation on a consolidated basis, a CNIT taxpayer would not have a limitation whether or not a standalone computation would have produced a limitation.
In computing the existence of an IRC Section 163(j) limitation on a separate company basis, a corporate taxpayer will need to include both intercompany and third-party interest in the analysis. The separate company analysis will include determining whether the corporate taxpayer has gross receipts sufficient to meet the requirements of IRC Section 163(j)(3), when calculated on a separate entity basis without elimination of related-party receipts. For purposes of implementing IRC Section 163(j), a corporate taxpayer will follow any elections actually made for federal income tax purposes by the taxpayer or its federal consolidated group under subparagraphs (B) or (C) of IRC Section 163(j)(7).
Interest Expense Associated with Related-Party Addback Provision
In the instance where a taxpayer adds back interest expense or costs under 72 P.S. Section 7401(3)2.(t) and is subject to an IRC Section 163(j) limitation, Corporation Tax Bulletin 2026-01 follows the rules in Corporation Tax Bulletin 2019-03. A corporate taxpayer with both disallowed related-party and third-party interest is required to allocate the federal limitation on a pro rata basis between the two amounts. Disallowed related-party interest would carry forward and potentially be deductible for federal separate company purposes in future tax periods. When disallowed interest is deductible for CNIT purposes, that amount will be added back for CNIT purposes. As a result, a corporate taxpayer will need to keep track of both its federal separate company interest deduction carryforward and the breakout of that amount between third-party interest expense and interest expense falling within 72 P.S. Section 7401(3)1.(t).
Interest Expense Associated with Nonbusiness Income
Corporation Tax Bulletin 2026-01 follows the rules in Corporation Tax Bulletin 2019-03 for allocating and applying an IRC Section 163(j) limitation in the instance where a CNIT taxpayer has interest expense associated with both business and nonbusiness income.
Section 382 Limitation on Interest Expense
Corporation Tax Bulletin 2008-03 provides detailed guidance on computing deductible interest where a corporate taxpayer that has a carryforward of interest expense previously limited under IRC Section 163(j) enters into a transaction for which IRC Section 382 applies. In this instance, the taxpayer should check the “Section 381/382/Merger NOLs” box on Form RCT-101 to advise the DOR that IRC Section 163(j) interest expense limitation carryovers are present, and provide the information set forth in Corporation Tax Bulletin 2008-03, including a schedule of carried over interest expense limited under IRC Section 163(j).
Note that Corporation Tax Bulletin 2026-01 does not address the treatment of interest expense previously limited under IRC Section 163(j) in a transaction for which IRC Section 381 applies. In this instance, the taxpayer also should check the “Section 381/382/Merger NOLs” box on Form RCT-101 to advise the DOR that IRC Section 163(j) interest expense limitation carryovers exist and provide the information set forth in Corporation Tax Bulletin 2008-03, including a schedule of carried over interest expense limited under IRC Section 163(j) and a copy of the relevant corporate documents evidencing the merger/liquidation.
Treatment of Interest Expense for Partnerships with Corporate Partners
Corporation Tax Bulletin 2026-01 follows the rules in Corporation Tax Bulletin 2019-03 regarding the application of IRC Section 163(j) for partnerships with corporate partners. For federal income tax purposes, the interest expense limitation is calculated for partnerships at the partnership level itself but then applied at the partner level. Once a partnership calculates its own federal interest limitation amount pursuant to IRC Section 163(j), interest and excess business interest expense (EBIE) amounts will flow to its corporate partner(s) in the same manner and percentage as other amounts flow up from the partnership to its corporate partner(s). In a tiered structure, a fixed interest limitation amount would flow up through multiple levels until it reaches one or more corporate taxpayers. A corporate partner would then follow the federal rules applicable to partners and partnerships to determine when or to what extent interest expense and EBIE may be deducted by the corporate partner.
The same rules apply for CNIT purposes. However, both the partnership and the corporate partner(s) would be required to calculate their IRC Section 163(j) limitation under the rules in effect as of Dec. 31, 2024. In addition, special rules apply in the instances where partnership interest expense may be associated with nonbusiness income, and a partnership has interest expense disallowed under 72 P.S. Section 7401(3)1.(t) (related-party interest) and a federal limitation under IRC Section 163(j).
Partnership Interest Expense Associated with Nonbusiness Income
For CNIT purposes, the determination of whether partnership income and interest expense constitute business income is made at the corporate partner level. (See 61 Pa. Code Section 153.39(c)(2).) What constitutes business interest for CNIT purposes is not the same as what constitutes “business interest” in calculating an IRC Section 163(j) limitation. In determining any IRC Section 163(j) limitation, all interest of a C corporation is treated as “business interest,” unless the amounts are designated to a specifically excluded type of business under Reg. Section 1.163(j)-10. Partnerships also will need to identify whether interest is properly classifiable as “business interest” in calculating the interest limitation passed through to its corporate partner(s).
Partnership Interest Expense Associated with Related-Party Addback Provision
A corporate taxpayer will need to determine its Pennsylvania interest expense addback from each partnership in which it owns an interest and report it on the Pennsylvania Corporate Tax Report for that year. The corporate partner will need to track these amounts on a partnership-by-partnership basis to ensure that future Pennsylvania addback amounts are included when the corresponding interest expense is able to be deducted for federal separate company income tax purposes.
The Corporation Tax Bulletin imposes the ultimate responsibility on a corporate partner to accurately compute CNIT liability, whether or not a partnership provides entity-level information, regarding the application of IRC Section 163(j), as in effect on Dec. 31, 2024. The strict application of Act 45 is likely to result in assessments, especially in instances where a corporate partner does not have the ability to compel a partnership to provide this information.
Personal Income Tax
The Pennsylvania PIT statute does not incorporate IRC Section 163(j). Interest expense is deductible if it constitutes an ordinary and necessary business expense. For purposes of calculating the resident credit – to the extent a resident taxpayer realizes increased income in another state based on the application of the limitations under IRC Section 163(j) by that state – the calculation should not be affected, as it is limited to the Pennsylvania PIT applied to the income as calculated under applicable Pennsylvania PIT rules.
Underpayment Relief
Both the revision to Corporation Tax Bulletin 2019-03 and the issuance of Corporation Tax Bulletin 2026-01 were issued after the due date for payment of tax for calendar year 2025 and contain no reference to underpayment relief. Taxpayers are encouraged to use the appeals process if relief is required because of these changes.
Peter N. Calcara is PICPA’s vice president of government relations. He can be reached at pcalcara@picpa.org.
Howard Sklaroff, CPA, is a member of PICPA’s State Taxation Steering Committee. He can be reached at hsklaroff@gmail.com.
The authors would like to thank all the members of State Taxation Steering Committee for their input and clarifications.
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