Section 163(j) in 2026: The Tightening Behind Last Year's Win

Mid-market borrowers got a real win in 2025: the Section 163(j) business interest limitation reverted to the more favorable EBITDA-based calculation, restoring depreciation and amortization add-backs that the 2022–2024 EBIT rules had stripped out. That change was effective for tax years beginning after December 31, 2024, and it was made permanent by the OBBBA.

The catch is what comes next. For tax years beginning in 2026, two less-friendly provisions take effect, and interest rates remain elevated with Fed action uncertain. So the headline benefit landed a year ago—and 2026 quietly narrows it for exactly the capital-intensive and multinational borrowers who benefited most. A bigger ceiling you celebrated in 2025 is not the same ceiling in 2026, and neither one lowers the actual cost of the debt.

What Actually Changed, and When

The timeline matters because the dates drive the planning:

• 2025 (tax years beginning after Dec. 31, 2024): ATI reverts to EBITDA—depreciation, amortization, and depletion add back into the calculation, expanding the 30% deduction ceiling. Permanent. This is the favorable change, and it is already in effect.
• 2026 (tax years beginning after Dec. 31, 2025): Two tightening provisions arrive. First, electively capitalized interest stays subject to the 163(j) limit—closing a planning route that previously let interest escape the cap. Second, certain foreign inclusions (Subpart F, the GILTI-successor CFC income, and the §78 gross-up) come out of ATI, shrinking the base for businesses with controlled foreign corporations.

Who the 2026 changes hit hardest:

• Multinationals with CFCs in the structure—the ATI exclusion can claw back a meaningful slice of the EBITDA benefit
• Businesses that relied on interest capitalization as a 163(j) workaround
• Capital-intensive firms that assumed the 2025 generosity carries forward unchanged

Who can largely ignore this:

• Businesses under the gross-receipts safe harbor (inflation-indexed; ~$31M for recent years—confirm the figure for your tax year), exempt entirely
• Domestic-only operations with no foreign subsidiaries and no interest-capitalization planning—for them, 2026 looks much like 2025

The takeaway the headlines miss: 2025 was the win, 2026 is the fine print. If your capital plan treats "the deduction got better" as a 2026 rationale for new leverage, it's built on last year's news and ignores this year's constraints.

The Rate Context: A Bigger Ceiling on an Expensive Bill

Even where the EBITDA cap helps, it doesn't touch the thing that actually hurts: the rate. The Federal Reserve's stance through early 2026 has effectively put a floor under borrowing costs. Prime sat in the 6.5–7.0% range heading into mid-2026, with rate-cut expectations muted and delayed. For businesses accessing SBA 7(a) loans, lines of credit, or commercial real estate financing, all-in rates commonly run 9.75% to 14.75% depending on credit profile, term, and market conditions.

Let that sink in: a mid-market company can be paying 10–15% on debt while the deduction ceiling has expanded. A wider ceiling provides tax relief on the interest expense. It does not reduce the expense.

Here's where the ceiling actually matters—a case where the limit genuinely bites:

• A capital-intensive company has EBITDA of $20M, but heavy depreciation and amortization of $8M, so EBIT is $12M.
• It carries $5M of annual interest expense.
• Under the EBIT basis (2024): the ceiling was 30% × $12M = $3.6M. Only $3.6M of the $5M is currently deductible; ~$1.4M is disallowed and carried forward.
• Under the EBITDA basis (2025+): the ceiling is 30% × $20M = $6M. The full $5M is now deductible.
• The restored add-back rescues ~$1.4M of deduction—worth roughly $290K–$350K in tax depending on effective rate.

That is a real benefit, and it shows why capital-intensive borrowers care. But notice what it is: a recovery of deductibility the EBIT years had taken away. It lowers the tax on the interest. The $5M of interest itself doesn't move. The deduction is a discount on the bill, not a cut to it—and for a company near or over the limit, the more pressing question is whether the debt should be that large or that expensive in the first place.

Integrated Planning: The Deduction Is One Input, Not the Decision

This is where most mid-market CFOs and tax advisors fall short. They evaluate 163(j) in isolation—"the ceiling expanded, so leverage looks better"—or they fixate on rates alone—"rates are high, so avoid debt." Neither view is sufficient.

The right framework integrates three variables:

1. Tax deduction ceiling (more favorable since 2025, narrowing for some in 2026)
2. Absolute cost of capital (still elevated)
3. Timing and refinancing risk (often ignored)

Consider two scenarios:

Scenario A: Growth capex financed with new debt

• A mid-market tech services firm plans a $3M acquisition.
• The EBITDA cap makes the after-tax cost of leverage look more attractive.
• But if rates drop 100–150 bps over the next 18 months, waiting could cut annual interest expense by $30–45K—every year, for the life of the loan.
• The incremental tax savings from the wider ceiling (~$10–15K annually, if the limit even binds) don't offset the opportunity cost of overpaying on rate now.

Scenario B: Refinancing existing high-rate debt

• A capital-intensive company has $10M at 11% maturing in 2027.
• The wider ceiling makes the refinancing math look marginally better.
• But refinancing in 2026, only to see cuts arrive in late 2026 or 2027, locks in an expensive rate.
• The $25–30K in incremental annual tax savings won't compensate for locking in 150+ bps of excess cost.

Neither scenario is automatically right or wrong. Both require modeling the deduction, the rate environment, and the refinancing timeline together.

The Stress-Test Approach: Building Decisions on Realistic Assumptions

Most firms project forward on a single base case—"prime stays at 6.75%, spreads stay flat"—then layer on the wider ceiling and conclude leverage is justified. That leaves significant risk unpriced.

A more useful framework stress-tests interest expense under two futures:

Scenario 1: Rates stay elevated through 2026

• Prime holds at 6.5–7.0%; spreads widen modestly.
• All-in borrowing cost: 10.5–11.5%.
• The ceiling is higher, but so is the cost of capital.

Scenario 2: Rates decline 100–150 bps from mid-2026

• Prime drops to 5.5–6.0%; spreads compress.
• All-in borrowing cost: 8.5–9.5%.
• Earlier borrowers overpaid; later borrowers get better terms.

The after-tax cost of capital under each scenario—not the deduction alone—should drive the timing decision.

ClearPath's Integrated Approach

At ClearPath Consultants, we've found the most valuable conversations around capital structure happen when tax specialists, financial advisors, and FP&A leaders sit at the same table. The restored EBITDA cap is material—but it's one input among many, not the decision itself, and in 2026 it comes with new conditions for some borrowers.

Our approach:

1. Model the deduction ceiling accurately using pro forma EBITDA under realistic operating scenarios—and account for the 2026 capitalization and CFC changes where they apply.
2. Project interest expense under base-case and stress-case rate assumptions.
3. Calculate the true after-tax cost of capital for each timing and structure alternative.
4. Quantify refinancing risk if rates decline (the cost of locking in today's rates vs. the upside of refinancing later).
5. Stress-test against covenant and leverage metrics to keep the capital structure resilient.

The goal isn't to minimize debt or maximize deductions. It's to minimize the true economic cost of capital while preserving financial flexibility—and that requires seeing all three variables at once.

Conclusion: The Deduction Is a Tool, Not a Strategy

The EBITDA-based 163(j) calculation that returned in 2025 is genuinely more favorable for many mid-market businesses. But a wider ceiling only helps if the underlying debt decision makes economic sense—and in 2026, the rule tightens for capitalized interest and for companies with foreign subsidiaries. With rates still elevated and Fed action uncertain, the temptation to rationalize leverage on tax efficiency is higher than it should be.

The right move: stress-test interest expense against a "rates stay high" scenario, model the true after-tax cost of capital under multiple futures, and time debt decisions around the integration of deduction, rates, and refinancing risk—not any one of them alone.

If your current capital plan leans on the deduction as the primary rationale for leverage, it's time for a deeper conversation. ClearPath Consultants helps mid-market leaders build integrated capital strategies that weigh tax efficiency, cost of capital, and risk management in tandem. Let's talk about how your debt and deduction strategy should evolve.