Are You Ready to Fall Off the Fiscal Cliff? What You Need to Know if the Bush Tax Cuts Expire


The times they are a changin’ for taxes in the United States if legislation doesn’t change things soon.  Most americans are unaware of their taxes will be reshaped by the impending “fiscal cliff.”

The phrase that is being tossed around in the media is “falling off the fiscal cliff” or “taxmageddon”, and both are fairly accurate as to the repercussions.

Understanding exactly what is going to happen if we fall of the fiscal cliff is critical to your personal finances for 2013, so we’re going to break down some of the big points for you.

Repercussions of Falling Off the Fiscal Cliff

This list is pretty terrifying unless you enjoy paying higher taxes.

Expiration of Payroll Tax Cut


For the last two years we have all enjoyed a 2% decrease in payroll tax for Social Security.

Normally you pay 6.2%, but we’ve all been paying 4.2%.  Self-employed individuals will go back to paying the full 12.4% in Social Security tax.  (Your employer pays the difference if you are a W2 employee.)

This is a minor tax increase, and one that should probably go back to being normal considering the current future of funding for Social Security.

Expiration of Bush Tax Cuts

This is the big one.

Here is a snapshot of the major taxes that would go up if the Bush tax cuts are allowed to expire.  There are a lot of nuances to the Bush tax cuts that I won’t go into, but these are the ones that will impact most individuals:

  • Tax bracket increases across the board
    • 10% bracket becomes 15%
    • 25% bracket becomes 28%
    • 28% bracket becomes 31%
    • 33% bracket becomes 36%
    • 35% bracket becomes 39.6%
  • Capital gains tax increase from 15% to 20%
  • Child tax credit goes down from $1,000 to $500
  • Estate tax rates up, estate tax exemption down, no longer able to deduct state or local taxes paid, and estate tax exemptions will not be portable between spouses
  • Dividend taxes will increase dramatically from 15% t0 39.6%

Expiration of Alternative Minimum Tax Patch

fiscal cliff

How dangerous to your taxes is it if we fall off the fiscal cliff?

The Alternative Minimum Tax was a good idea when it was first written into law.  The intent was to keep extremely wealthy individuals from using specific tactics to avoid paying any tax at all by requiring them to pay tax by a different set of rules called the Alternative Minimum Tax.

The only problem is the income level that would trigger the AMT was never set to inflation.

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As incomes rise with inflation more and more middle class earners are caught up by the AMT.  That means each year Congress has to pass a band-aid patch that increases the exemption to a certain amount to make sure those important middle class voters aren’t hit too hard.  The most recent patch will expire if nothing is done about the fiscal cliff.

Expiration of Unemployment Benefits

The extended unemployment benefits many individuals have been surviving on will expire.

New Healthcare Taxes Kick In

On top of previous tax cuts expiring — essentially increasing taxes from their current levels — Congress has new taxes for us as part of the Affordable Care Act.

The Medicare tax will increase for those earning over $200,000 by 0.9%.  Additionally, a 3.8% surtax on net investment income will kick in for those with a high enough modified adjusted gross income (MAGI).

Those MAGI levels are:

  • $200,000 if filing Single or Head of Household
  • $250,000 if Married filing Jointly
  • $125,000 if Married filing Separately

Required Spending Cuts

On top of the tax cuts there will be automatic cuts to spending on defense and non-defense.

The hit to the defense spending ranges from 9.4% to 10%, the hit to payments to Medicare providers will be 2%, and the hit to non-defense spending (things like education and research) range from 7.6% to 8.2%.

The overall amount that was supposed to be covered through both tax increases (or expiration of tax cuts) and decreased spending was $1.2 trillion.  A majority of that hole is made up through the tax increases.  However, $109 billion is scheduled to be cut from spending.

Will We Really Fall Off the Fiscal Cliff?

Congress has elected to consistently kick the can down the road when it comes to dealing with our massive debt load and overspending.

The same thing happens with individuals in debt: instead of spending less than they earn, they just take on more debt, increase their minimum payments, and keep on with the status quo.

At the very least the fiscal cliff forces Congress to once again reevaluate our current predicament.

However, I just can’t believe that all of those elected officials will let such a shockingly high tax increase to occur overnight.  They are elected officials, and they’ll want to keep their records clean for the next election.  I do think reforms are necessary, perhaps including paying higher taxes across the board, but having every tax increase hit all at the same time would be significantly unpopular.

I would imagine some sort of compromise would be found before Congress leaves for the holiday recess; essentially another band-aid on a massive problem that no one wants to tackle because they don’t want to be unpopular and end up unelected the next time around.

What do you think will happen with the impending fiscal cliff?

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Published or updated May 24, 2013.

Comments

  1. The taxes either go up now or they go up in the future. The government needs a way to reduce the debt they have pilled on.

    • Agreed. The debt has to be paid for at some point and we’re gonna be paying at least some of it. But hopefully they do something to ease all of these taxes that could potentially pile on at once.

  2. Tony Bearden says:

    Taxes need stay static and spending by the government go down. None of this means squat without serious entitlement reform of SSN, Medicare, and the monstrosity known as Obamacare. I’m very pessimistic, no elected official wants to do anything that could hurt there chances on the gravy train of working in government.

    • There is a problem of those wanting to keep people happy with low taxes and lots of programs in order to keep in office. But taxes have been raised in the past without losing office.

      There’s a lot that needs fixing.

  3. Jenna, Adaptu Community Manager says:

    Thanks for explaining this fiscal cliff. Maybe some will expire and some will be renewed?

  4. I expect that something will be done because the economy is precarious at best. I also think that Congress will work together, but I was fooled before on that.

  5. I was surprised to hear House Republicans were willing to work with the President. We’ll see if it really happens or not. We need some major reform everywhere and the tax code needs some major help.

    • They will work together in some way, shape, or form. Let’s face it, neither the Dems nor ‘Pubs want to pay all those taxes that can potentially rear their ugly heads.

  6. I believe that people deserves to get more from their money. The government needs to work on reducing taxes. Unfortunately, it keeps on increasing and I can see the upward trend continues until my children are able to pay their own taxes.

  7. This article makes no sense!

    The Bush tax cuts were only for the rich, so most people won’t be affected.

    And the Healthcare law doesn’t raise taxes either. The President said as much.

    This is just more Republican talking points about the “Dangers” of raising taxes on the rich. This week’s election proves the people are not being your talking points!

    • Sarcasm? It’s always been misleading to imply the capital gains rate was only for the rich–it applies to all.

  8. I fully expect something to be done very soon. With the president getting re-elected, I expect the momentum to carry on the getting a few things, including this, done very quickly.

    • Define “getting done”.

      We’re here because the government has been kicking the can down the road. I see no reason to suspect they won’t do so again. Especially when it can be used as a political tool.

  9. I think everyone is feeling anxious about what will happen and whether they will fall off the “fiscal cliff.” I watched President Obama speak about it this afternoon but we still don’t know what will happen.

  10. Darren Fong says:

    Oh come on, the “fiscal cliff” isn’t the end of the world. It’s highly-exaggerated by the media and people like you to prey on people who don’t understand it.

    Going over the “cliff” may hurt stock markets and lead to slightly slower economic growth for the next few years, but we really need to reign in on government spending. By avoiding the fiscal cliff, we may be delaying economic doomsday for now, but it’s going to continue snowballing.

    I’d rather pay more taxes and go over the cliff, than ruin our future generations.

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