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House Tax Reform Bill: What Investors Need to Know

The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party, nor should the analysis be considered tax advice.

House Republicans unveiled their long-awaited tax reform legislation on Nov. 2, firing the starting gun on a two-month race to approve the most sweeping overhaul of the tax code in three decades by the end of the year.

The road ahead is far from smooth. As lawmakers dig into the details of the 400-page bill, we expect some changes to be made in the weeks ahead and potentially a few controversies—particularly in the narrowly-divided Senate, which is expected to introduce its own version of tax reform later this month.

Here are some of the points that may be of interest to investors:

  • Fewer brackets, though the top rate for the wealthiest filers is unchanged. As promised, the bill reduces the number of brackets for most Americans to three: 12%, 25% and 35%. But it maintains the current top rate of 39.6% for individuals earning more than $500,000 and couples earning more than $1 million per year.
  • No changes to retirement savings incentives. One of the most discussed elements of the potential tax reform package in recent weeks was a proposal to lower the cap on contributions to tax-advantaged 401(k) accounts and instead require most retirement savings contributions to be made to Roth accounts, for which contributions are taxed up front. But after considerable public outcry and a tweet from President Donald Trump flatly stating that there would be no changes to 401(k) plans, the bill’s authors dropped the provision.
  • No changes to taxation of investment income. The bill calls for the tax rates on capital gains and dividend income (currently 0%, 15% and 20%, depending on income) to remain unchanged. It also makes no changes to the Net Investment Income Tax, the 3.8% surtax on investment income for wealthier filers that is part of the Affordable Care Act. That provision was supposed to have been eliminated as part of the effort to repeal the ACA, which foundered earlier this year. For the time being, at least, the surtax is here to stay.
  • Eliminates the estate tax—in 2024. The bill immediately doubles the exemption for estates (to $11.2 million for individuals, $22.4 million for couples in 2018) and then eliminates the estate tax entirely in 2024.
  • Preserves the “step-up in basis.” Heirs will continue to be able to pay capital gains taxes based on the value of the asset at the time of the death of the previous owner, not at the time the previous owner acquired the asset.
  • Eliminates the Alternative Minimum Tax. Getting rid of the unpopular AMT was a key plank of the Republican strategy from day one.
  • Nearly doubles the standard deduction. As expected, the bill increases the standard deduction from $6,350 to $12,000 for individuals and from $12,700 to $24,000 for couples.
  • Reduces the deduction for home mortgage interest. Current law allows homeowners to deduct the interest on mortgages up to $1 million. The House bill caps interest deductions for mortgages at $500,000 for new purchases. Expect this to be a particular point of contention in the weeks ahead.
  • Eliminates most deductions and credits. This is where the heart of the debate will be, as the bill eliminates hundreds of popular tax incentives, including those for medical expenses, student-loan interest and adoption expenses. As expected, the bill eliminates the state and local tax deduction, providing only a deduction for state and local property tax that is capped at $10,000. For lawmakers representing constituents in high-tax states like California and New York, this will be a bitter pill to swallow.
  • No changes to treatment of tax-exempt municipal bonds. Investors had been keeping a wary eye on whether the tax plan would change the treatment of muni bonds, but the bill contains no changes.

What happens next

House leaders foresee a very brief timeline in that chamber, starting with consideration by the House Ways and Means Committee this week. Since many committee members have been involved for weeks in the drafting of the bill behind closed doors, that step should be relatively smooth, though amendments to the bill will be considered. Assuming the committee approves the bill by the end of the week, the full House would then consider the bill during the week of Nov. 13. Final passage in the House could come before the chamber adjourns for the Thanksgiving recess on Nov. 17.

The path is much murkier in the Senate, where Republicans hold a narrow 52-48 majority. Senate Finance Committee Chairman Orrin Hatch (R-UT), who will shepherd the process in the upper chamber, plans to introduce his own version of tax reform. It could be quite different from the House bill. Hatch’s committee would then have to review the bill, consider amendments and approve sending it to the Senate floor.

The Senate floor is where things could get complicated. Even using special rules that limit debate, limit amendments and, most importantly, prohibit Democrats from filibustering the legislation, Senate floor debates are free-wheeling, unpredictable affairs. The biggest challenge facing Republican leaders will be cobbling together 50 votes to pass a bill.

Once the Senate and House have each passed their version of tax reform, the two chambers will need to have a conference to reconcile the differences and produce a single, identical bill. Then each chamber will need to pass that version before it can be sent to the president for his signature. Accomplishing all that before the end of the year is plausible, but hardly certain.

Bottom line for investors

We don’t suggest investors take any action at this time. The release of the House’s bill is the first step in what will surely be a lengthy process, and changes to the bill are inevitable. The biggest stumbling block remains the Senate, where getting to 50 votes isn’t a sure thing. Clarity will come only as the process unfolds in the weeks ahead.

What you can do next

  • If you’ve built a solid financial plan and a well-diversified portfolio, it’s best to ignore the political noise and focus on your long-term goals. Want to talk about your portfolio? Call our investment professionals at 800-355-2162.

  • Watch Schwab experts discuss other market and economic topics in the Schwab Market Snapshot.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.


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