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Tax Reform Bills Progress, but Many Hurdles Remain

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.

Sweeping tax reform legislation has made significant progress in Washington, but there are still numerous hurdles that need to be overcome before the bill becomes law.

The House approved its version of the tax bill on Nov. 16 by a vote of 227-205. No Democrats voted in favor of the bill, and 13 Republicans also opposed it.

The Senate bill, which differs from the House version in significant ways, was approved on Nov. 16 by the Senate Finance Committee on a strict party-line vote. The bill now heads to the Senate floor, where its fate is uncertain in the narrowly-divided chamber.

Both the House and Senate are now in recess for the Thanksgiving holiday. The Senate is expected to begin consideration of the tax reform bill shortly after lawmakers return to Washington on Nov. 27.

Here’s what investors need to know about the differences between the bills and what might happen next:

  • The differences between the two bills are big and will need to be resolved before a law is passed. The House bill, for example, has four individual tax brackets, while the Senate version has seven. In the Senate version, the individual tax cuts “sunset,” or expire, in 2026, while the House bill makes the individual tax cuts permanent. The House bill repeals the estate tax in 2024; the Senate bill does not. The Senate plan cuts the corporate tax rate to 20% in 2019; the House version lowers the rate to 20% beginning in 2018. These are just a few examples of dozens of provisions, large and small, that will eventually have to be negotiated between the chambers.
  • State and local tax deduction remains the biggest potential flashpoint. Both the House and Senate bills eliminate the state and local tax deduction, but the House bill preserves a deduction of up to $10,000 for property taxes. The Senate bill contains no such provision. Almost all of the House Republicans who opposed the bill represent constituents in states with high state and local taxes. Several others who supported the bill did so only after Republican leaders promised that additional state and local tax relief would be included in the final package. Finding a compromise that satisfies everyone will be very tricky.
  • The Senate bill contains a significant change for investors. The Senate bill would require individual investors to use the “first in, first out” (FIFO) method to calculate capital gains or losses when selling stock. Investors would no longer be able to pick and choose which shares to sell. Requiring that the oldest shares be sold first could result in larger capital gains—and higher taxes—for investors. This provision is likely to be debated further as the bill progresses. There is no comparable provision in the House-passed bill.
  • No changes to retirement savings. A provision in the Senate bill that would have eliminated the “catch-up” contribution for high-earners age 50 and over was dropped, and talk that some retirement contributions would be required to go to Roth accounts, which are taxed at the time of the contribution, never materialized. As things stand now, retirement savers should not see any significant changes as the result of either bill.

What happens next

The Senate is set to begin debate on the bill early in the week of Nov. 27. Senate rules strictly limit the amount of debate, so the bill should be completed by the end of that week. But its passage remains far from a certainty.

With only a 52-48 majority, Republicans can lose the votes of only two members of their party (Vice President Mike Pence would break a 50-50 tie). Already, however, Ron Johnson (R-Wisc.) has said he is opposed to the bill in its current form, and Susan Collins (R-Maine) has expressed serious concerns.

Other potential wild cards include John McCain (R-Ariz.), who has made a long career out of going his own way on key legislation, and two Republicans who have announced that they will not run for re-election in 2018: Bob Corker (R-Tenn.) and Jeff Flake (R-Ariz.). Since neither has to face voters again, their positions on the bill have become less predictable.

If the bill passes the Senate, the House and Senate would need to convene a conference to negotiate and reconcile differences between the two bills to produce a single consensus bill. That bill would then need to be approved by both chambers before it could be sent to President Donald Trump for his signature. Negotiations between the two chambers will likely be extremely challenging, given the differences between the two approaches.

Republican leaders are optimistic that they can pass a consensus tax package by early to mid-December, but that remains uncertain.

Bottom line for investors

We believe the prospects for a tax reform bill being signed into law before the end of the year are improving, but a number of tricky steps must still be overcome.

For investors, we still think it is too early to take any drastic action. The bill is virtually certain to be changed many times in the weeks ahead. If and when a tax bill passes, there will be time to review the details and amend your tax and financial plans accordingly. Regardless of the outcome of the tax bill, it’s always a good idea to meet with your tax and financial advisors before the end of the year to review your current financial situation and discuss your plans for the coming year.

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.

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

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

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