Pennsylvania Decouples from Federal Interest Expense Rules

The Pennsylvania Department of Revenue (Department) on September 10, 2026, issued Corporation Tax Bulletin 2026-01, providing updated guidance on how the Commonwealth will treat the federal interest expense limitation under Internal Revenue Code (IRC) § 163(j) for Corporate Net Income Tax (CNIT) purposes.

Effective for tax years beginning on or after January 1, 2025, Bulletin 2026-01 is a significant overhaul of the Department's Section 163(j) guidance and establishes a clear transition from its prior revised guidance under Corporation Tax Bulletin 2019-03. Though Bulletin 2026-01 provides some clarity to the Department's position in an area of growing complexity, it also introduces fundamental changes that raise several practical and legal questions that taxpayers should carefully evaluate.

Background: A Static Conformity Approach

When the Tax Cuts and Jobs Act of 2017 was enacted, it amended Section 163(j) and imposed limitations on the deductibility of business interest expenses for federal income tax purposes for tax years beginning on or after January 1, 2018. Pennsylvania responded by issuing Bulletin 2019-03, which addressed the state-level treatment of the federal limitation. With some exceptions, Bulletin 2019-03 adopted the federal framework in imposing the Section 163(j) limitation but applied it on a separate-entity basis.

Significantly, however, Bulletin 2019-03 provided that if a federal consolidated group is not subject to any limitation on the deduction of its current year interest expenses under Section 163(j), the Pennsylvania corporate taxpayer that is part of the consolidated group would also not be subject to an interest expense limitation for CNIT purposes. Thus, many taxpayers who participate in federal consolidated returns with no Section 163(j) interest expense limitation may fully deduct interest expenses on their CNIT returns. The Department updated this position and revised Bulletin 2019-03 on July 30, 2026, to limit its applicability to tax years beginning before January 1, 2025.

When the One Big Beautiful Bill Act (OBBB) was enacted in 2025, it further amended and modified the calculation of the Section 163(j) limitation at the federal level. Under OBBB, the interest deduction limitation is calculated based on a more favorable method, using earnings before interest, taxes, depreciation and amortization (EBITDA), rather than the prior method of using earnings before interest and taxes (EBIT).

However, when Pennsylvania passed its budget on November 12, 2025, and the accompanying Fiscal Code, Act No. 45 of 2025, the Commonwealth fixed its conformity to the version of Section 163(j) in effect as of December 31, 2024. Consequently, modifications to the calculation of the Section 163(j) limitation under OBBB do not apply for CNIT purposes (i.e., taxpayers must calculate their Section 163(j) limitation using EBIT). In issuing Bulletin 2026-01, the Department implements this static conformity date while departing from its prior position and revoking the safe harbor for consolidated filers under Bulletin 2019-03. Bulletin 2026-01 also provides taxpayers detailed guidance on separate-entity calculations, the interaction between Section 163(j) and Pennsylvania's related-party interest addback rules, treatment of nonbusiness income, updated compliance for partnerships with corporate partners, and the interaction between Section 163(j) carryforwards and Section 382 limitations.

Key Provisions of the Bulletin

Below are the key changes under Bulletin 2026-01 that companies should be aware of and consider as they prepare and file their CNIT returns, beginning with tax year 2025:

• Elimination of Consolidated-Filer Safe Harbor and Separate-Entity Calculation. Bulletin 2026-01 requires taxpayers to compute their federal interest expense deduction on a separate-entity basis, using the provisions of Section 163(j) as they existed prior to the changes enacted by OBBB. The federal changes under OBBB do not apply for Pennsylvania CNIT purposes. Taxpayers filing as part of a federal consolidated group must prepare and perform its own pro-forma separate company Section 163(j) analysis, regardless of whether the federal consolidated group reports a limitation. The Department acknowledges that though exceptions exist – particularly around consolidated return regulations – the "general intent" is that the federal regulations in effect as of December 31, 2024, will be followed "to the extent practicable."
• Intercompany and Third-Party Interest. The separate-company framework requires taxpayers to include both intercompany and third-party interest expense in their Section 163(j) calculations. Calculated on a separate-entity basis without eliminating related-party receipts, each entity with a Pennsylvania CNIT filing obligation must independently determine whether the interest limitation applies, including the small business exception under Section 163(j)(3).
• Interaction with Pennsylvania's Interest Addback. One of the more complex aspects of Bulletin 2026-01 concerns how Section 163(j) interacts with Pennsylvania's existing related-party interest addback statute contained in 72 P.S. § 7401(3)1.(t). The Department instructs taxpayers to allocate the federal limitation on a pro-rata basis between related-party interest subject to the addback and third-party interest. Because the federal rules make no distinction between the respective interest amounts, taxpayers must separately track disallowed related-party interest that would carry forward under the federal rules and potentially be deductible for federal separate company purposes in future years, in addition to the breakout between third-party and addback-eligible interest.
• Nonbusiness Income Allocation. Because the distinction between business and nonbusiness income is a state-level concept not addressed by federal Section 163(j) authority, Bulletin 2026-01 directs taxpayers with nonbusiness income to allocate their interest limitation on a pro-rata basis between business and nonbusiness interest expense.
• Interaction with Section 382. Bulletin 2026-01 provides additional guidance addressing the interaction between Section 163(j) interest expense carryforwards and Section 382. If taxpayers have existing interest expense carryforwards that were limited by Section 163(j) and those taxpayers undergo ownership changes that trigger Section 382, the taxpayers must conduct analysis on the potential additional limitation by Section 382 on the use of the Section 163(j) carryforward amounts.
• Partnership Treatment. For partnerships with corporate partners, Bulletin 2026-01 follows the federal approach of calculating the interest limitation at the partnership level and applying it at the partner level. In tiered structures, the fixed interest limitation amount flows up through multiple partnership levels until it reaches one or more corporate taxpayers. The Department expects partnerships to provide supplemental information calculated in accordance with Pennsylvania's conformity rules but ultimately places the compliance burden on the corporate partner.
• Personal Income Tax Unaffected. For Pennsylvania Personal Income Tax (PIT) purposes, the deductibility of interest expenses continues to be determined by whether they constitute ordinary and necessary business expenses and not by reference to specific IRC provisions. As such, the Section 163(j) framework does not apply in the PIT context.

Holland & Knight Insights

Although Bulletin 2026-01 fills an important guidance gap and provides a clear transition from revised Bulletin 2019-03, it introduces a number of issues that could give rise to disputes or administrative challenges:

• Reliance on "To the Extent Practicable" Language. Bulletin 2026-01 concedes that federal regulations in effect as of December 31, 2024, will be followed "to the extent practicable." This open-ended language gives the Department significant discretion to decide when it is – and is not – "practicable" to follow the federal framework without providing taxpayers clear criteria. This vagueness may invite inconsistent application and could be challenged as an impermissible delegation of interpretive authority through an informal bulletin rather than through properly promulgated regulations.
• Increased Compliance Burden and Administrative Complexity. Bulletin 2026-01's requirement that each taxpayer perform a separate-entity calculation using a frozen version of Section 163(j) effectively asks corporations to maintain a parallel tax computation system. Taxpayers who file as part of federal consolidated groups will need to deconstruct their consolidated interest computations and reconstruct them on a separate-entity basis using superseded rules. For multistate taxpayers, this requires ensuring that entity-level data is captured and maintained at the individual, separate company level and may require costly updating of tax software and compliance workflows. Additionally, varying conformity dates across jurisdictions also adds another layer of increasing complexity in reconciling federal and state interest expense deductions.
• Carryforward Tracking Complexity. Bulletin 2026-01 requires taxpayers to track multiple distinct carryforward buckets – federal separate-company interest deduction carryforwards, the breakout between third-party and addback-eligible interest within those carryforwards, and a Pennsylvania-specific interest addback carryforward – each of which requires a separate set of computations when amounts become deductible in future periods. The layered pro-rata calculations described in Bulletin 2026-01, particularly when previously disallowed interest becomes partially deductible, introduce meaningful complexity and opportunity for error. These tracking requirements are arguably more detailed than what the statutory text of Pennsylvania Act 45 of 2025 contemplates, which could invite a challenge as to whether the Bulletin exceeds the scope of the underlying legislation. Over time, the frozen conformity date may also make it increasingly difficult to apply federal regulations "to the extent practicable" if the regulatory framework evolves in ways that render the 2024-era rules internally inconsistent.
• The Bulletin's Legal Status. Tax Bulletins are not regulations. They represent the Department's interpretation of the law but do not carry the force of law in the same manner as properly promulgated regulations. Taxpayers who disagree with positions taken in the bulletin may argue that these positions constitute substantive rulemaking that should have gone through a formal regulatory process.

Bulletin 2026-01 provides clarity on which set of rules govern a given tax year for taxpayers navigating Pennsylvania's approach to Section 163(j) after OBBB. However, the bulletin's reliance on informal guidance to adopt a less favorable position and address deeply technical issues may prove its vulnerability. Taxpayers facing material Pennsylvania CNIT exposure should evaluate whether the bulletin's requirements align with their operations and consider whether there are grounds to challenge specific provisions. As other states continue to chart their own courses on Section 163(j) conformity, Pennsylvania's approach will serve as one important data point in an evolving multistate landscape.

For more information or questions, please contact the authors.

Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.