The Fiscal Cliff: Why Your Tax Rates Could Increase Next Year

With the election looming and the political season in full swing, we’re now inching closer every day to what many are calling the “fiscal cliff”.  The fiscal cliff is the metaphorical tax rate drop-off we’ll reach and fall into when2013 hits if no legislation is passed in order to extend the current tax rates, deductions and other tax provisions.

Right now we’re enjoying the lower tax rates due to the Bush era tax cuts that have been extended by the Obama administration. If nothing is done by Congress in the final months of the year, tax rates would increase substantially, paychecks would shrink due to expiring social security tax cuts, and extended jobless benefits could also expire.   So what things can you expect to see happen if the 2013 Fiscal Cliff is reached, and nothing is done?

Who Will The Fiscal Cliff Affect?

So just how many Americans will be affected by the fiscal cliff?  A majority of us will be affected if nothing is done to avert the expiration of tax rates, etc. From CBS:

It’s estimated that 80 percent of Americans will see some form of tax increase next year. The Bush tax cuts alone would impact 100 million Americans. The Tax Policy Center estimates that the average U.S. household would face an average of a $3,700 jump in taxes.

So around 80 percent of taxpayers would see an increase, and the average household would see a jump of $3700 in their taxes.

I’m not sure about you, but personally I don’t like the thought of an increase that big.  That’s huge, especially when most families are already struggling to get by in a tough economy.

Analysts have speculated that allowing all the tax cuts, deductions, etc to expire would mean that we would go into another recession and unemployment would increase, while extending them would mean an increase to the deficit.  It’s a choice we’ll have to make.

The Congressional Budget Office said that the U.S. economy would slide into a “significant recession” as a result of the tax increases and spending cuts. CBO estimates that the economy would shrink by 2.9 percent in the first half of 2013 and by 0.5 percent for the whole year. The fiscal cliff would also likely increase the nation’s unemployment rate, from the current 8.1 percent to 9.1 percent

What Tax Cuts, Deductions and Provisions Are Expiring?

So just which tax cuts, deductions and other tax provisions are expiring at the end of 2012 in order to cause the fiscal cliff? Here are a few of the major ones:

• Bush tax cuts expire: If the Bush era tax cuts were to expire after a 2 year extension by Obama, we would see the tax rates increase for basically all taxpayers.  The curent federal income tax brackets would be increasing 3-6%.  The current tax bracket rates are at 10%, 15%, 25%, 28%, 33% and 35%.   They would increase to 15%, 28%, 31%, 36% and 39.6% respectively if they weren’t renewed.
• Social Security payroll tax cut ends: The payroll tax cut which was extended for 2012 will expire, meaning an increase of $1000 in taxes on average.
• Child tax credit would drop: The $1000 child tax credit would be cut in half to $500, from the current $1000.
• Earned Income Tax Credit goes away:  One thing that could hurt low and middle income taxpayers is the fact that the Earned Income Tax credit, which is a refundable tax credit, would go away.
• Estate taxes increase:  Currently the first $5 million of an estate avoids estate tax.  Above $5 million it would have a 35 percent tax rate. If it expires the exemption would drop to $1 million, and the tax rate would go up exponentially to 55 percent.  This could definitely hurt those with small family owned businesses.
• High earners may be subject to new Medicare surtaxes: Those earning more than $200,000 single or $250,000 married filing joint may be subject to new surtaxes on investment income, as well as an increase in the Medicare payroll tax.
• The marriage penalty.. It’s back: The standard deduction for married filers would no longer be twice that of a single filer – re-engaging the so called “marriage penalty”.
• Dividends taxed as ordinary income: The tax on dividends goes up from 15 percent to as much as 39.6 percent, which could be extremely bad for many seniors who rely on dividends.

Those are just some of the more major things that will be happening on 1/1/2013 if nothing is done by congress.  There will also be spending cuts happening in Medicare and defense that could have some pretty large effects.

Will Congress Act To Avoid A Fall Off The Fiscal Cliff?

Right now it appears dubious that any long term legislation will be enacted to avoid the fiscal cliff, and it appears the best that we can hope for right now is a delay of 3-6 months in the deadlines of the tax cut expirations so that Congress can put together a comprehensive and bipartisan solution.

Slowly and quietly, the U.S. Congress may be arriving at a consensus on how to avoid falling off the “fiscal cliff” on December 31 – by simply putting off its own deadline for most of the major year-end budget and tax decisions.That approach would delay the day of reckoning while also allowing more time for compromise in a Congress that has battled for two years over how best to reduce huge budget deficits…

Congressmen from both sides of the aisle have floated ideas to extend the deadlines into March, others extending it into June.  What exactly would happen would then be largely dependent on who gets elected on November 6th. All of this makes the elections that much more meaningful.

• Want to figure out how much extra you’ll be paying next year if nothing is done about expiring rates and deductions?  Check out this fiscal cliff tax burden calculator. Running the calculator showed me I’ll probably be paying about $3600 extra in taxes next year. How about you?

What would you like to see happen? Do you think we need to extend the tax rates, or would you be in favor of allowing them to expire?  How much extra will you be paying? Tell us your thoughts in the comments.