Republican election gains will chill the prospects for major tax legislation over the next two years, but there may still be limited opportunities for bipartisan agreements as early as this year.
Republicans will take back control of the House, though with a significantly narrower majority than polls had predicted. Democrats will retain the Senate with at least a 50-49 majority, with the final race in Georgia going to a Dec. 6 runoff election. Republicans had hoped for more sweeping election gains, but House control alone will be enough to end Democrats’ two-year stint with single-party control.
Partisanship remains high, and with a contentious 2024 presidential election looming, the next two years could be dominated by gridlock. But there still may be room for narrow bipartisan tax compromises. The election results potentially boost the chances for a lame-duck agreement on several tax priorities, including:
- Retroactively restoring expensing of research and experimentation (R&E) costs under Section 174
- Extending 100% bonus depreciation, which will revert to 80% for property placed in service after 2022
- Retroactively providing relief from the limit on interest deductions under Section 163(j)
- Enacting a package of retirement plan changes often referred to as “SECURE 2.0”
- Raising the recently lowered threshold for payment settlement network reporting on Form 1099-K
- Providing auto dealers relief from supply chain issues affecting the last-in-first-out accounting method
Winning both the House and Senate would have left the GOP less interested in negotiating with Democrats and more inclined to wait for 2023. The prospect of a split Congress next year could bring both sides back to the table to discuss a year-end tax package when they reconvene to consider government funding before it expires on Dec. 16. Democrats have been demanding expensive enhancements to the child tax credit in exchange for the business tax provisions, initially a nonstarter for Republicans. Hope for deal has grown in recent weeks as both sides appear to have softened their stances.
Grant Thornton Insight
Passing the tax extenders was historically less controversial, but momentum has flagged as the list of annual provisions shrinks. Democrats in particular have less at stake this year because the energy tax provisions were already extended under the IRA. The retirement incentives and R&E expensing may have the best outlook, as both enjoy widespread Democratic support. Though there is still hope for a deal, the outlook is uncertain enough that taxpayers should consider how a legislative failure could affect their estimated tax payments, financial statements and business plans. This should include assessing the impact of amortizing R&E costs and potentially accelerating investments to place property in service before 100% bonus depreciation is scheduled to expire.
There will be fewer opportunities for bipartisan tax initiatives next year. The defining tax policy issue may be the potential implementation of a global minimum tax under the Pillar 2 framework form the Organisation for Economic Cooperation and Development (OECD). The current U.S. international tax regime shares core concepts with elements of the Pillar 2 agreement, but it is widely viewed as noncompliant. The administration has been pushing to amend international tax rules to align the U.S. with the global agreement.
Republicans have criticized the global deal. If the rest of the world moves toward implementation over the next two years without the U.S. action, the potential for negative consequences for U.S. multinationals could lead to a political blame game between congressional Republicans and the White House.
Grant Thornton Insight
The administration is hoping U.S. businesses facing unfavorable one-sided implementation will eventually lobby for U.S. action and force the GOP’s hand. Bipartisan action may be possible, but the business groundswell that would be needed has not yet materialized.
Regulatory action and IRS enforcement
The loss of the House could prompt the Biden administration to turn to more aggressive regulatory action, including from Treasury and the IRS. Former President Barack Obama, for example, issued sweeping anti-inversion regulations when facing a Republican Congress in his second term. Former President Donald Trump ordered a review of all recent tax regulations after taking office, and later considered indexing capital gains to inflation through regulation after Republicans lost the House.
Favorable regulations implementing the Tax Cuts and Jobs Act could be a potential target, though Treasury officials have given no signs of aggressive intentions in the area. For now, the IRS and Treasury will be preoccupied with issuing guidance implementing the new provisions in the Inflation Reduction Act (IRA).
The Biden administration will also have a unique opportunity to reshape the IRS over the next two years with $80 billion in new funding from the IRA. President Biden recently nominated Boston Consulting Group executive Danny Werfel to be the next IRS commissioner. Werfel has served in both Republican and Democratic administrations and was briefly the acting IRS commissioner in 2013. Treasury Secretary Janet Yellen has announced no plans to depart.
Grant Thornton Insight
House Republicans will be able to use their new majority to step up oversight, and the IRS will likely be a major target. Republicans have already begun using the additional IRS funding as a political talking point, saying the funding lacks oversight and will hurt taxpayers. They cannot, however, cut IRS funding without legislation signed by the president.
Debt limit as leverage
The debt limit could provide Republicans an opportunity to push for policy concessions from the administration on spending or tax policy. House Minority Leader Kevin McCarthy, R-Calif., has expressed interest in using the debt limit as leverage for policy changes, including to Medicare and Social Security. The three Republicans vying to be the next chair of the Ways and Means Committee have expressed support for such an exercise, though with varying degrees of enthusiasm. These efforts could also be complicated by what is expected to be a very slim majority for Republicans.
Grant Thornton Insight
Using the debt limit as a catalyst for policy changes has been difficult in the past. The Obama administration and House Republicans did agree on legislation imposing mandatory “sequestration” of discretionary spending before raising the debt limit in 2011, but efforts since then have generally failed. It is a politically perilous gambit to use a government default as a threat because an actual default is viewed as so catastrophic. Democrats have discussed raising the debt limit through reconciliation during the lame duck session, but this would be very difficult both politically and procedurally.
Even if Republicans cannot extract major policy concessions from Democrats, they will be in position to force tough votes on extending popular aspects of the Tax Cuts and Jobs Act. House control would offer Republicans a more powerful platform for messaging in advance of 2024.
The 2024 election will be very important for tax policy. The scheduled expiration of major aspects of the TCJA and other changes could trigger major tax reform efforts following the election. The following provisions are all set to expire at the end of 2025:
- All individual provisions from the TCJA, including rate cuts, the Section 199A deduction, the cap on state and local tax deductions, and the increases in the child credit and standard deduction
- The Work Opportunity Tax Credit
- The New Markets Tax Credit
- The Controlled Foreign Corporation look-through rule
In addition, the Section 250 deduction is scheduled to shrink from 50% to 37.5% for global intangible low-taxed income and from 37.5% to 21.875% for foreign-derived intangible income. The base erosion and anti-abuse tax rate is scheduled to increase from 10% to 12.5%.
Grant Thornton Insight
The scheduled changes are so significant that it could force broad reconsiderations of tax policy, even for provisions like the corporate rate that are not themselves scheduled to change. The scheduled expiration of the 2001 and 2003 tax cuts in 2010, for example, led to a broader tax policy negotiations. Democrats had considerable leverage because they appeared more willing to let the tax cuts expire altogether. The 2001 and 2003 tax cuts were initially extended for two years before Democrats successfully forced Republicans to compromise on an extension that cut out most of the benefits to high-income taxpayers. Democrats could have similar leverage in 2025 if they hold any lever of power and are less invested in preserving the TCJA than Republicans.
Taxpayers should closely monitor the prospects for lame duck action on important tax provisions like R&E cost expensing and bonus depreciation. Whether legislation passes could have a significant impact on financial statements, estimated tax payments, and the tax impact of investments.
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