Tax outlook remains uncertain with new Congress

The new Congress convened last week to infighting and messaging votes, potentially portending two years of divisive debate over tax and spending policy.

The split government makes major tax legislation very unlikely, but many taxpayers were hoping there would be opportunities for narrow bipartisan agreements on unfinished tax priorities like restoring research and experimentation (R&E) cost expensing under Section 174. Contentious infighting among Republicans in the House complicates the picture.

It took 15 tries for Rep. Kevin McCarthy, R-Calif., to secure enough votes to be elected House speaker, and he had to agree to several rule procedural changes that could make governing more difficult. Several of the changes also have potential implications for tax legislation, including: 

• Cut-as-you go (CUTGO): The package swaps the old “pay-as-you-go” requirement for a “cut-as-you-go” requirement — meaning House legislators may only pay for new spending with offsetting spending cuts. No new taxes are allowed to pay for additional new spending.
• Supermajority on taxes: Tax rate increases would require a three-fifths supermajority vote to pass the House.
• Debt-limit vote: The package eliminates the so-called “Gephardt rule,” which allowed the House to avoid a direct vote on lifting the debt limit.

Conservatives also reportedly secured a pledge from McCarthy to allow the House to vote on legislation to replace the income tax with a national sales tax. In addition, in one of their first legislative actions, Republicans voted 221 to 210 to rescind most of the $80 billion in funding from the Inflation Reduction Act (IRA). Neither bill is expected to move further in the face of opposition from President Joe Biden and Democratic Senate, but they signal that Republicans are intensely focused on tax messaging in front of the 2024 elections. That fact could make a tax extenders deal more difficult. 

Short-term outlook for extenders

Hopes for a tax title in the year-end government funding omnibus bill were dashed as Democrats and Republicans could not agree on an extension of the enhanced child tax credit in exchange for legislation addressing expiring Tax Cuts and Jobs Act (TCJA) provisions — like retroactively restoring expensing of R&E costs under Section 174, extending 100% bonus depreciation (which reverted to 80% for property placed in service after 2022), and retroactively providing relief from the limit on interest deductions under Section 163(j).

Businesses still are pushing for action on these priorities, and negotiations could resume, but the same issues that scuttled a deal at the end of last year are still in play. At this point, taxpayers should be assessing the impact of these TCJA changes on tax planning, estimated tax payments and financial statements. 

Ways and Means Chair

Rep. Jason Smith, R-Mo., won the race to lead the House Ways and Means Committee, giving him to the ability to shape the party’s approach to tax, trade and health policy in the House. Smith beat out two other, more senior lawmakers — Rep. Vern Buchanan, R-Florida, and Rep. Adrian Smith, R-Neb., for the post.

Smith is a staunch ally of both McCarthy and former president Donald Trump, and has already indicated he will be focused on oversight of the administration, particularly IRS funding. 

Smith has also been a proponent of using the debt limit to push for policy concessions from the administration on spending or tax policy. The rule changes in the House indicate there may be broad support among Republicans for such efforts. Using the debt limit as a catalyst for policy changes has been difficult in the past, and some moderate Republicans have already signaled they would potentially try to work with Democrats to undercut any brinkmanship that could threaten the full faith and credit of the U.S. government. Rep. Brian Fitzpatrick, R-Penn., recently noted that “a discharge petition would only take myself and four colleagues on the GOP side to side with Democrats, if that’s necessary to circumvent that.”

Negotiations on the debt limit may intensify in the coming months, as Treasury Secretary Janet Yellen stated last week that Treasury is now utilizing “extraordinary measures” to continue paying the nation’s debt. Yellen also noted that Treasury’s power to delay a default could be exhausted by early June.

Republicans in the House may seek to pass messaging bills laying their tax agenda (e.g., extending provisions of the TCJA and/or repealing provisions of the IRA), even though these bills are likely to flounder in the Democrat-controlled Senate. Conversely, Democrats may continue proposing social spending programs funded by tax increases on the wealthy and large corporations that will likely not pass in the Republican-controlled House.

Given the anticipated lack of major substantive legislative activity, focus likely will remain on the administrative guidance process. The IRS has already issued initial guidance on the IRA's corporate alternative minimum tax, stock buyback excise tax and green energy provisions — though much more guidance on these provisions and other aspects of the IRA are expected in the coming months.