House Tax Reform Bill Released: Would Cause Major Changes to US Tax System

by Dechert LLP

Dechert LLP

The U.S. House of Representatives GOP conference released its long-awaited tax reform bill, the Tax Cuts and Jobs Act (the “House Bill”), on Thursday, November 2, 2017. The House Bill, if enacted in its current form, would produce significant changes to the U.S. taxation of corporations and individuals (including income received through pass-through entities) and would significantly alter the U.S. taxation of international operations of U.S. taxpayers. On Monday, November 6, 2017, House Ways and Means Committee Chairman Rep. Kevin Brady offered an amendment that was subsequently approved by the Ways and Means Committee (the “First Brady Amendment”). On Thursday, November 9, 2017, Chairman Brady released a second amendment (the “Second Brady Amendment”), with the House Ways and Means Committee approving the Second Brady Amendment and the overall House Bill on the same day. The House Bill remains subject to continuing negotiations within the U.S. House of Representatives GOP conference and needs to be reconciled with a separate U.S. Senate GOP tax reform bill expected to be released this week. Several of the important features of the House Bill are summarized below.

Corporate Tax Rate, Deductibility of Interest, NOLs, and Expensing

The House Bill would reduce the corporate income tax rate from 35% to 20% (with a 25% rate for personal service corporations). 

The House Bill would significantly limit the deductibility of interest expense by a business, regardless of the form of the business. Interest deductions would be capped at the amount of the business’s interest income earned plus 30% of its annual adjusted taxable income. Adjusted taxable income, a proxy for EBITDA, generally would be determined by adding back to taxable income any (i) net operating loss (“NOL”) deduction, (ii) interest expense (but subtracting interest income), and (iii) depreciation and amortization. For businesses organized as partnerships, this limitation on the deductibility of interest expense would be determined at the partnership level. Interest deductions disallowed due to this limitation would be carried forward for up to 5 years but would remain subject to the overall calculation of the limitation on deductibility. Multinational corporate groups may be subject to an additional, more complex interest deduction limitation based on worldwide financial statement consolidated interest expense, including the interest expense of non-U.S. affiliates. The lower of the two limits will apply.

  • Practice Note: The proposed changes to corporate tax rates and the deductibility of interest expense described above may significantly offset one another, with the overall effect dependent upon the particular facts. For example, under current law a U.S. corporation with US$100 million of EBITDA, debt of 6x EBITDA (US$600 million) with a 10% interest rate (all allowed as a deduction), and no tax deduction for depreciation or amortization, would generally pay a tax rate of 35% on US$40 million of net income (US$100 million - US$60 million), for an overall federal tax bill of US$14 million. Under the proposed rules set forth in the House Bill, the same U.S. corporation would generally pay a tax rate of 20% on US$70 million of net income (US$100 million - US$30 million of allowed interest expense), and would therefore have exactly the same federal tax bill (US$14 million). If EBITDA is reduced in the example, the proposed rules would increase the tax burden on the business compared with current law. Using the same example, if EBITDA is reduced to US$80 million, under current law, the company would generally pay a tax rate of 35% on US$20 million of net income (US$80 million - US$60 million) for an overall federal tax bill of US$7 million. Under the House Bill, despite the already reduced cash flow, the federal tax bill would increase to US$11.2 million ((US$80 million - US$24 million) x 20%). 

Under the House Bill, corporations would be prohibited from carrying back NOLs but would be allowed to carry forward NOLs indefinitely, and any unused NOLs would be increased by an interest factor to preserve their value. The House Bill limits the ability to reduce taxable income with an NOL deduction to 90% of taxable income.

The House Bill also would allow taxpayers to immediately expense 100% of the cost of qualified property, now including used property, placed in service before 2023. In addition, the deduction for domestic production activities, currently in Code Section 199, would be repealed.

The Second Brady Amendment would also reduce the amount of corporate dividend received deductions to reflect the lower corporate income tax rates for less than 80% owned corporate subsidiaries. 

Taxation of Individuals

Lower Tax Rate on Pass-Through Income

The House Bill would provide owners of a pass-through entities, such as limited liability companies and S corporations, with a maximum tax rate of 25% on certain business income earned from such entities, subject to several limitations. This preferential rate generally applies to all business income derived from a business in which the owner does not materially participate (a “passive business activity”), including, for example, a passive private equity investment, but the preferential rate would generally apply to only 30% of business income from a business in which the owner materially participates (an “active business activity”). Assuming the owner of an active business activity would be eligible for the preferential rate on 30% of business income and would be subject to the highest individual marginal rate of 39.6% on the remaining 70% of taxable income, the blended marginal rate would be roughly 35%. However, where the active business activity is capital intensive, an individual would be able to apply the preferential rate to a percentage of income from the business in excess of 30%. Income from businesses primarily engaged in professional services (including financial services, law, accounting, consulting, engineering, or performing arts) would generally not be eligible for the 25% rate, subject in limited cases to an exception allowing partial access to the 25% rate when a threshold amount of capital is invested in the business. In connection with these changes, the House Bill (prior to its amendment by the Second Brady Amendment) would have repealed the “limited partner exception,” which generally excludes a limited partner’s income from self-employment tax, and would instead have generally subjected an individual partner to self-employment tax on the partner’s business income not subject to the preferential tax rate. The Second Brady Amendment restored the current-law treatment of the application of self-employment tax to amounts received through pass-through entities in the House Bill, including the “limited partner exception.”

Potential Limitation on Carried Interest

The First Brady Amendment would generally impose a new 3-year holding period requirement for service providers to receive long-term capital gain from carried interests granted with respect to real estate or investment businesses. This provision would not change the ability under current law for the carried interest to be received tax-free. Separately, U.S. Treasury Secretary Steven Mnuchin has indicated that the Trump Administration will pressure Congress to repeal the preferential tax treatment of carried interests.

Consolidation of Individual Tax Rates and Elimination of Deductions

The House Bill would consolidate the current seven individual income tax brackets on ordinary income into four brackets: 12%, 25%, 35% and 39.6%. Although the highest marginal rate of 39.6% would remain unchanged from current law, the threshold for income to be subject to this rate would increase (from roughly US$470,000 to US$1 million for married couples filing jointly). The benefit of the 12% rate would be phased out gradually for certain high-earning taxpayers, giving rise to a 45.6% marginal income tax rate on income between US$1.2 million and approximately US$1.6 million for married couples filing jointly, with the marginal income tax rate returning to 39.6% thereafter. The bill would roughly double the standard deduction to US$24,000 (for married couples filing jointly), while it would eliminate numerous existing deductions (including the deduction for personal exemptions and the deduction for state and local income taxes and property taxes in excess of US$10,000) and repeal the alternative minimum tax (for all taxpayers). The 3.8% Medicare tax on net investment income (including income from a passive business activity) would be retained, as would the current preferential individual tax rates for long-term capital gains and qualified dividend income, although the proposed increase in the highest marginal rate threshold would cause a corresponding increase in the threshold for long-term capital gains to be subject to the maximum 20% capital gains rate.

Deferred Compensation

Prior to its amendment by the Second Brady Amendment, the House Bill would have imposed new rules on nonqualified deferred compensation, including stock options and stock appreciation rights, generally requiring that such compensation be included in income when an employee’s right to such compensation is no longer conditioned on the future performance of substantial services, without regard to payment or certain non-service related contingencies, such as change in control or satisfaction of a business performance goal. These new rules would not have applied to deferred compensation in respect of services performed before 2018; however, any such deferred compensation would be included in income no later than 2025. The Second Brady Amendment withdrew these proposed rules from the House Bill. Separately, the First Brady Amendment would amend Code Section 83 to allow, in certain circumstances, a qualified employee who receives qualified stock to elect to defer recognizing income in respect of the stock for a period of up to five years after the employee’s rights in the stock vest.

Super Tax-Exempts

The House Bill makes explicit that all entities exempt from tax under Code Section 501(a) would be subject to the unrelated business taxable income (“UBTI”) rules, even if tax-exempt under another code section (e.g. Code Section 115), including state pension plans (so-called “super” tax-exempt investors). If enacted, it will be interesting to see if this provision is challenged on Constitutional grounds (i.e. federal taxation of a state sovereign). 

Changes to International Tax Rules 

By adopting a dividend exemption mechanism and other changes, the House Bill would move the U.S. closer to a territorial system. The dividend exemption would allow a U.S. corporate taxpayer a deduction for 100% of the foreign-source portion of the dividends the U.S. corporation received from foreign corporations in which it owned a 10% or greater interest, subject to holding period requirements. The bill also disallows a foreign tax credit for any foreign taxes paid or accrued with respect to foreign dividend for which the deduction is allowed. In addition, the bill deems all previously untaxed foreign earnings to be repatriated, and would subject such repatriated earnings to tax at reduced tax rates: 14% for earnings held in cash or cash equivalents and 7% for the remainder. Prior to adoption of the Second Brady Amendment, these rates were 12% and 5%, respectively. Taxpayers would be able to elect to pay those taxes over an eight year period in equal installments. Code Section 956, which currently treats U.S. shareholders of controlled foreign corporations (“CFCs”) with untaxed foreign earnings as receiving a dividend when the CFC invests in U.S. property, would be repealed. The House Bill also includes an excise tax on certain payments of specified amounts made by U.S. corporations to non-U.S. corporate affiliates. The existing CFC and passive foreign investment company (“PFIC”) regimes would for the most part be preserved, and a new CFC rule would be added which taxes currently income of a CFC that exceeds a certain rate of return on the tax basis of a CFC’s assets (the “High Return Amount”).

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Dechert LLP | Attorney Advertising

Written by:

Dechert LLP

Dechert LLP on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.