House tax writers approved more than $2 trillion in tax increases on Sept. 15 to fund a massive reconciliation bill Democrats are racing to complete by Sept. 27. The tax hikes are offset by more than $1.2 trillion in proposed tax cuts.
The House action finally translates the Democratic tax agenda into concrete legislative language. Although the tax package survived several days of mark-up with no substantive changes, it still represents a starting point in the legislative process. The tax title will be added to other spending titles into a broader reconciliation bill. Many of the House tax provisions remain contentious and could change significantly to shore up Democratic support before it goes to the House floor. Negotiations with Senate Democratic moderates will also continue to shape the bill.
The House tax title aligns fairly closely to the tax platforms laid out by President Joe Biden’s tax proposals and Senate Democrats, but there are significant differences in some areas. Key revenue raisers include:
- Raising the top corporate rate 26.5%
- Raising the top individual rate to 39.6%, plus a 3% surtax
- Raising the top capital gains and qualified dividend rate to 25%, plus a 3% surtax
- Expanding the 3.8% tax on net investment income (NII)
- Capping the Section 199A deduction at $400,000 (single filers) and $500,000 (joint filers)
- Creating new limit on the interest deduction
- Repealing the 100% gain exclusion for qualified small business (QSB) stock
- Cutting the unified estate and gift tax exemption in half
- Significant reform of international tax rules, including to the tax on global intangible low-taxed income (GILTI), the foreign-derived intangible income (FDII) deduction, the base-erosion anti-abuse tax (BEAT), and foreign tax credits (FTCs)
The bill also includes substantial tax cuts, including:
- Delaying the effective date of five-year amortization of R&D costs from 2022 until 2026
- Increasing the work opportunity tax credit to 50% and providing a minimum wage cap of $10,000 in first-year wages and $10,000 in second-year wages all groups except summer youth employees
- Enhancing tax-favored bond provisions
- Allowing tax-free conversions from an S corporation into a partnership before the end of 2023
- Enhancing the rehabilitation credit
- Making permanent the new markets tax credit
- Enhancing the low-income house credit
- Providing more than $230 billion in clean energy extensions and enhancements
- Providing more than $830 billion in tax incentives and enhancements for health coverage, higher education, child and depending care tax credits, child tax credits, and earning income tax credits
Most of the changes are proposed to be effective beginning in 2022 or later, with some important exceptions. The proposed change in the capital gains and dividend rate is generally effective for transactions after Sept. 13, 2021, with transition relief for sales subject to a written binding contract.
There are several areas where Democrats made significant concessions, but many others where they appear very aggressive, perhaps as a starting point for further negotiations. The corporate rate proposal was reduced from 28% to 26.5%, but that still may be too high for moderates who have called for corporate rates no higher than 25%. The 25% capital gains rate is notable retreat from Biden’s proposed 39.6% rate, but the 3% surtax may raise objections.
There are also several notable omissions from the mark-up, including:
- Relief from the cap on state and local tax (SALT) deductions
- Repeal of the step-up in basis for inherited assets
- Minimum tax on financial statement income
- Repeal of like-kind exchanges
- Repeal of oil and gas tax incentives
SALT cap relief remains a sticking point. House Ways and Means Committee Chair Richard Neal, D-Calif., has pledged to include “meaningful SALT relief,” but negotiations continue. Several moderate Democrats have threatened to oppose any bill unless the cap is fully repealed, but this seems unlikely. Negotiators have discussed a temporary repeal or an increase in the cap.
Some of the other omitted revenue raisers could also surface again during the legislative process as lawmakers scramble for revenue. But controversial provisions like the minimum tax on book income and the repeal of basis step-up at death appear much less likely to gain traction now. Senate Finance Committee Chair Ron Wyden, D-Ore., has also released a handful of revenue-raising discussion drafts he hopes to eventually add to the bill, including:
- Significant and unfavorable changes to partnership rules
- 2% excise tax on stock buybacks
- Rules requiring mark-to-market of derivatives for some taxpayers
The bill itself still faces major hurdles. There are deep divisions between moderate and progressive Democrats and very slim margins for error. The reconciliation process allows Democrats to bypass filibusters in the Senate, but with only 50 Senate seats, they cannot lose a single vote. In the House, they can currently only lose only three votes to pass legislation without Republican support.
Senate Democratic moderates like Sens. Joe Manchin, D-W.V., and Kyrsten Sinema, D-Ariz., have said they cannot support a $3.5 trillion bill. The tax title raises over $2.1 trillion, and drug pricing provisions and economic growth are supposed to cover the rest of the package. Biden recently met with Manchin and Sinema to try and shore up support.
The fate of the reconciliation bill may be tied to the bipartisan infrastructure bill that has already passed the Senate. Democratic leaders have been holding the infrastructure bill hostage in the House to force moderates on board the reconciliation process. But House moderates refused to vote on the budget resolution without language providing for an infrastructure vote by Sept. 27. Although this deadline is nonbinding, leadership is losing leverage over moderates as it approaches. Lawmakers are therefore racing to complete a reconciliation bill in just weeks.
Although the ultimate outlook is not certain, some taxpayers may benefit from pre-emptive tax planning. Most of the proposals include prospective effective dates, meaning there is a potential window of opportunity to plan in front of changes.
The following provides more information on key proposals and their outlook for enactment.
The bill would replace the flat 21% corporate rate with three brackets of 18%, 21%, and 26.5%, with the 26.5% rate imposed on income exceeding $5 million. An additional 3% tax would be imposed on income exceeding $10 million until the benefit of the lower brackets is erased. The rate change would be effective for tax years beginning after 2021. Under Section 15, fiscal year taxpayers would prorate their rate based on the proportion of their fiscal year occurring after Dec. 31, 2021. The proposal would also increase the 50% dividends received deduction to 65% and the 65% deduction to 72.5%.