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.
Shortly before 2 a.m. on December 2, the Senate approved sweeping tax legislation by a 51-49 vote, clearing a critical hurdle and significantly increasing the likelihood that a tax bill will be signed into law before the Christmas holiday.
But work remains to be done. Next up is conference between the House and the Senate to reconcile differences between the two bills and produce a single, consensus agreement. Each chamber would need to pass that agreement in exactly the same form before the legislation could be sent to President Donald Trump for his signature.
Reaching consensus between the two chambers won’t be easy; there are significant differences between the two bills that will need to be resolved. The conference process will begin this week and Republican leaders are optimistic that a deal can be struck within a matter of days.
Complicating matters, the two chambers also must find time this week to avert a government shutdown and approve legislation that extends funding to keep the government open and operating. The current agreement to fund government operations expires on December 8; a government shutdown would begin on December 9 if no extension is approved. Republican leaders are pushing for a two-week extension, through December 22, that would buy time in order to finish the tax legislation.
It’s shaping up to be an extraordinary week in Washington as lawmakers wrestle with a pair of complicated negotiations simultaneously.
Tricky tax bill negotiations
The tax bill conference is exactly what it sounds like: A group of lawmakers from both chambers will gather in a room and haggle over the details of the final bill. There are a host of issues large and small that will need to be reconciled.
Among the most significant is the fact that the House-passed bill has four individual tax brackets, with a top rate of 39.6%, while the Senate legislation has seven tax brackets and a top rate of 38.5%. Moreover, all of the individual tax provisions in the Senate bill “sunset,” or expire, after 2025. The House plan makes virtually all of the individual tax changes permanent.
Another major difference involves the alternative minimum tax (AMT). In a last-minute amendment, the Senate decided not to repeal the AMT, choosing instead to increase the amount of income that is exempt from the tax. But the House bill includes a complete repeal of the AMT, an idea that has been a cornerstone of the party’s tax platform for years.
There is also a discrepancy in how the two bills treat so-called “pass-through” businesses, like S corporations, LLCs and partnerships. This was a major point of debate in the Senate—the provision had to be changed in order to secure the support of at least two key Republicans—but it still is not the same as the House formula. This is one of the most complicated areas of the two bills and will take some time to reach consensus.
And there is also a significant difference in the deduction for mortgage interest. The House bill caps the deduction at the amount of interest homeowners pay on mortgages up to $500,000. The Senate bill keeps current law, which allows a deduction for the interest on a mortgage of up to $1 million.
For investors, a key unresolved issue centers on how investors calculate their cost basis on stock sales. The Senate bill would require investors to use the “first in, first out” (FIFO) method for calculating their cost basis. No longer could shareholders choose which lots to sell for tax purposes. But the House bill contains no such provision. Several House leaders have expressed opposition to the proposal and it is expected to be point of negotiation during the conference.
These are just a few examples of dozens of ways in which the two bills differ. Crafting a consensus bill will be a test for Republican leaders. The key is whether they can make changes to address different constituencies—some lawmakers, for example, are looking for more relief on the state and local tax deduction, while others are concerned about the bill’s impact on the national debt. Many individual lawmakers have concerns about dozens of specific provisions. Satisfying all of them will be a challenge.
Many of the differences are caused by strict budget rules in the Senate that limit how much long-term impact the bill can have on the national debt. Because the Senate passed the bill with just a single-vote margin, the chamber is likely to have the upper hand in the negotiations since changes that are too drastic could alter the precarious balance.
Timing for completing the conference is uncertain and will depend on how negotiations progress. Republicans are eager to pass the bill before the holiday break.
Government shutdown possible?
Resolution of the tax bill could be hindered by the threat of a government shutdown at the end of the week.
In the House, Republican leaders will push forward with a two-week extension of funding, and that should be approved without too much drama.
But the issue is far more complicated in the Senate. Republicans, who hold a 52-48 majority, will need the support of at least eight Democrats to reach a filibuster-proof supermajority of 60 votes. That gives Democrats extraordinary leverage to try to extract concessions from the majority party.
Some Democrats favor forcing a shutdown, arguing that since Republicans control both chambers of Congress and the White House, they would shoulder the bulk of the blame for failing to pass a budget.
Investors should not overreact
Investors should avoid overreacting to either of these unfolding dramas in Washington. Historically, government shutdowns have had little market impact. There have been 17 shutdowns of at least one day since 1976, and the average market impact has been less than 1% to the negative.
With regard to the tax bill, until the agreement is finalized, there is little for investors to do. But a year-end conversation with your financial advisor is always a good idea, and a discussion of the potential impacts to your tax situation as a result of the legislation would be prudent.