Virginia’s Business Interest Deduction Crunch Decoupling from Section 163(j)

One of the most overlooked but financially impactful changes in Virginia’s 2026 decoupling legislation involves the treatment of business interest expense. Under the federal Tax Cuts and Jobs Act (TCJA), IRC Section 163(j) generally limits a business’s deduction for net interest expense to 30% of its adjusted taxable income (ATI). Any interest expense that is “disallowed” under this limit can be carried forward indefinitely. For state tax purposes, many states, including Virginia, historically allowed a similar add-back and deduction for disallowed interest. However, under HB 29, Virginia has significantly tightened its rules.

For tax years beginning on or after January 1, 2025, Virginia has decreased its deduction for disallowed business interest expenses from 50% to just 20% of the interest disallowed on the federal return . This means that if a Virginia business has $100,000 of interest expense disallowed federally under Section 163(j), it can only deduct $20,000 of that amount on its Virginia return, with the remaining $80,000 representing a permanent, not temporary, difference. This change dramatically increases the state tax liability for leveraged businesses, including real estate investment entities, private equity-owned portfolio companies, and capital-intensive manufacturers. The decoupling from federal interest deduction rules creates a permanent “Virginia-only” add-back, directly impacting cash flow and effective tax rates. Businesses need to model the impact of this change immediately. At Nova Tax & Accounting Services, our Accounting & Bookkeeping and tax strategy teams can help you calculate the precise impact of the Section 163(j) decoupling and explore restructuring options to mitigate its effects.