The Senate returned from its summer recess and worked primarily in committee to advance its comprehensive budget reconciliation bill (see below). The House was in recess but also worked in committee to advance its version of the budget reconciliation bill.
The House is expected to vote on the defense authorization bill and a short-term government funding bill. However, the overarching focus for the Senate and House will be ironing out differences between the two chambers’ budget reconciliation bills to facilitate consideration over the next few weeks.
Budget Reconciliation Bill
Moves Forward. Two dozen House and Senate committees have been working on tax and spending aspects of the comprehensive budget reconciliation bill that fall within their respective jurisdictions. Committees were directed to finalize their plans by September 15, but few deadlines are met in Washington. The House committees have largely finished their work and are moving more quickly than their Senate counterparts. The next step is for these separate House bills to be consolidated into one single package by the budget committee. The full House could vote on it as early as the week of September 27. More time will be needed in the Senate where the opposition of just one Democrat can sink these efforts. The House and Senate committees have tried to develop similar bills, but differences are inevitable. While there will be disagreements among Democrats on the details of the package, we still believe both chambers will pass a final bill in October.
The House Ways and Means Committee passed the reconciliation bill’s major tax provisions this week. We sent you our views and the committee’s summary of these provisions when they were introduced on Monday. The following covers the tax provisions about which we have received the most questions from clients and colleagues.
- Capital Gains and Dividends. The committee voted to increase the capital gains rate to 25% for high-earners. Importantly, this rate also would apply to qualified dividend income. As we anticipated, the effective date was tied to the date of the bill’s introduction (September 13, 2021). We have been asked if this effective date will move as the Senate weighs in with its own proposals. While that is possible, we don’t think the effective date will change.
- Small Business. The House tax bill makes several changes that will impact small businesses. For starters, the bill eliminates the 20% pass through deduction for business owners making more than $400,000 ($500,000 for married couples). This proposal raises just over $78 billion in revenue. Another provision would extend the scope of the 3.8% net investment income tax from Obamacare to cover net investment income derived in the ordinary course of a trade or business for taxpayers (including trusts and estates) with income greater than $400,000 ($500,000 for joint filers). This proposal will raise over $252 billion. Additionally, the bill reverts the Qualified Small Business Stock (QSBS) tax exemption to 50% (down from 100% today) for those earning over $400,000. Given the popularity of small businesses on Capitol Hill, some of these provisions could be scaled back in a final bill.
- Retirement. For years, Democrats been concerned about so-called “Mega-IRAs.” In fact, almost a decade ago, President Obama proposed limitations on retirement accounts. Reports earlier this year about a famed investor having a retirement account well in excess of $1 billion poured gasoline on the fire. This has provided the impetus for Democrats to pursue a few significant changes, including a prohibition on the “Mega-backdoor Roth” strategy. The House bill also would prohibit wealthy individuals from contributing to retirement accounts exceeding $10 million and require them to take a new minimum distribution on these accounts. It would also repeal Roth conversions in individual retirement accounts and defined contribution plans (such as 401(k)s) for individuals making more than $400,000 a year. Many Senate Democrats are also interested in pursuing these policies, and we believe they are good candidates for a final bill.
- Estate Taxes. The House bill lowers the estate tax exemption level to the 2010 level (after an adjustment for inflation). Earlier this week, we had cited an exemption level of $5.5 million (the level it was before Republicans passed their tax cut bill in 2017), but the Joint Committee on Taxation has estimated that the 2022 level would be $6.02 million (after taking into account the inflation adjustment). While the Senate may seek to alter this proposal, we believe a lower exemption levels will be included in a final bill.
The Process Forward.
Things will be extremely fluid over the next few weeks regarding the composition of the tax components of the budget reconciliation bill. Very few provisions, particularly those relating to corporate taxes, are set in stone. We will send updates as major developments occur, but also don’t hesitate to contact us with any questions.
October 1 Breather.
With so much focus on the crafting of the budget reconciliation bill, there is less attention on the September 30 deadline to enact new government spending to keep agencies and departments funded into the new fiscal year that begins on October 1. Select party leaders are working in both chambers to pass a short-term funding bill before October 1 to avert a government shutdown. This has been a bipartisan exercise and should quietly succeed. However, the short-term solution will simply kick the can down the road. Congress will need to pass additional short-term extensions later in the year. This exercise could get very controversial and difficult if efforts are made to add a debt ceiling extension to the bill (see below).
Debt Ceiling Extension.
Treasury has announced that it will be unable to pay the country’s debts beyond an unspecified date in the mid-October to mid-November time frame. Of course, any threat to extending the debt ceiling could have a major impact on financial markets. That risk is heightened by the hyper-partisan atmosphere in Washington these days. Congress will somehow lift the debt ceiling this fall, but exactly how it does so is still difficult to predict. One thing that is clear is that this increase is likely to happen only after a contentious partisan fight that will further exacerbate tensions on Capitol Hill. Congressional Republicans have leverage by withholding their support, but they also risk being blamed for a potential failure in the markets and a threat to the US as a safe place to invest. The debt ceiling debate will focus on the appropriate levels of tax and spending – perhaps the biggest issues that philosophically divide the parties – and could be resolved by a bipartisan statement to somehow address deficit reduction, arguably a laughable notion in Washington these days.
China Investment Restrictions.
Both the Congress and US regulators have concerns about the risks to US investors from investing in Chinese companies. Due to home country regulatory restrictions, many Chinese companies list shares in US markets through offshore shell companies. In response to further restrictions and more stringent requirements by the Chinese government this summer, SEC Chairman Gary Gensler has indicated that the Commission is working to enhance disclosure requirements on the risks associated with these investments. A more longstanding concern has been the failure of Chinese companies to comply with US auditing rules relating to US regulators’ access to audit papers. In response, Congress passed legislation that became law late last year that directs the SEC to delist companies that fail to comply over a three-year period. The Senate recently passed a bill that would shorten this period to two years. At a Senate Banking Committee hearing this week, SEC Chairman Gensler expressed support for this bill, which could help galvanize its consideration in the House. Amidst increasing risks for US investors in Chinese companies, the chance of forced de-listings over the coming years seems increasingly likely.
Five separate House and Senate committees held hearings this week on the controversial withdrawal of US troops and Afghan allies from Afghanistan. Remarkably, the hearings featured expressions of outrage from not only Republicans but from Democrats as well. This issue has had an adverse effect on President Biden’s standing in national polls over the last three weeks (his approval ratings have dropped well below 50% in every major poll we have seen). Whether the issue will still rank high on the minds of voters in next year’s mid-term elections is an open question. We think it will given the likely steady stream of headlines over the next few months about who was left behind and how the hasty withdrawal was executed. The negative impact on relationships with our allies and on the US reputation more generally will only add to this issue’s potency as a political issue next year.