Fiscal Cliff 2012


Now that the Presidential race is over and we know who will be leading our country for the next 4 years, all attention has turned to the serious financial challenges that face our nation if Washington fails to take action by this December 31st, 2012 the date which marks The Fiscal Cliff.

 

The consequences of going off The Fiscal Cliff is a combination of two major government actions that were set in place during 2011 and 2012; Automatic government spending cuts (commonly referred to as Sequestration) and significant Tax Increases, all of which equates to somewhere between $500 to $817 Billion in deficit reduction, which is also referred to as Taxmaggedon. While both the tax increases and the spending cuts will have a significant impact on the US and global economies, they will have the most drastic impact on American families and business owners.

 

So whether you are an investor, a small business owner, a home owner or unemployed, inaction by Congress will affect you. So it is important for families and business owners to know what is included in these tax increases so that they understand the impact on their financial future and can make the necessary changes going forward. The following highlights, at a high level, the various topics currently being discussed in Washington that will have the most significant impact on the majority of Americans.

 

These are the major issues the President and Congress must act on:

 

  • The Payroll Tax Holiday
  • The Affordable Care Act (ACA)
  • Debt Ceiling and the Budget Control Act
  • Alternative Minimum Tax (AMT)
  • Bush Tax Cuts
  • Unemployment Benefits
  • The “doc fix”

 

The Payroll Tax Holiday expires

For 2011 and 2012 the employee portion of FICA was reduced by 2%. This reduction will end on December 31st which means starting in January the FICA amount withheld from your Paycheck will increase by 2%.

 

The Affordable Care Act (ACA) or Obamacare

The Affordable Care Act included two new taxes to help cover the cost of the increased Healthcare benefits. These taxes are;

  • Unearned Income Medicare Tax (UIMC) – 3.8% on unearned income.
  • Increased Hospital Insurance (HI) tax – 0.9% on earned income for individuals with more than $200,000 in income and married couples filing jointly with more than $250,000 in income.

Additionally, the ACA raises the threshold to claim medical expenses as an itemized deduction from 7.5% to 10% of adjusted gross income for individuals under age 65.

 

Debt Ceiling and the Budget Control Act (Sequestration)

The current debt ceiling is $16.394 Trillion and at the time of writing this article the US Public Debt subject to limit is $16.166 Trillion and is increasing at an average of $3.87 Billion /day.

The Budget Control Act or Sequestration will kick in at the beginning of 2013 which will dramatically cut funding to many government departments as described below:

  • 9.4% reduction in Non-exempt defense discretionary funding (keeping military bases open, paying salaries and research and development)
  • 10% reduction in Non-exempt mandatory defense spending
  • 8.2% reduction in Non-exempt, non-defense discretionary funding (Congress authorized programs such as Head Start and AIDS assistance)
  • 7.6% reduction in non-exempt, non-defense mandatory programs (Not much left here to cut. Most are exempt)
  • 2% reduction in Medicare budget

 

Alternative Minimum Tax

The Alternative Minimum Tax (AMT) patch which has historically been renewed at the end of each year, ended last year. So currently the AMT will affect 30 million more Americans this year unless congress patches it again.

 

Bush Tax Cuts

What is referred to as the Bush Tax Cuts will expire on December 31st, 2012. The Bush Tax cuts are the changes that were made by the 2001 EGTRRA and the 2003 JGTRRA acts.

In 2001 EGTRRA was passed which:

  • Lowered income tax rates

The expiration of the Bush Tax cuts will revert the income tax rates back to rates prior to 2001

10% bracket – gets rolled back into the 15% bracket

25% bracket – returns to 28%

28% bracket – returns to 31%

33% bracket – returns to 36%

35% bracket – returns to 39.6%

 

  • Changed deductions and credits(Marriage penalty returns)

EGTRAA increased the standard deduction for joint filers by allowing tax payers who file as married filing jointly who do not itemize, to claim the standard deduction for both spouses (i.e. 200% of the deduction). This will revert back to only 167% of the deduction.

The 2012 standard deduction is set at $11,900 which will be reduced to $9,900 in 2013.

Dependent Care Credits will go from $3,000 to $2,400 for a single dependent and from $6,000 to $4,800 for two or more dependents.

 

Child-care credit maximum will be reduced from $1,000 per child to $500 per child.

 

Student Loan debt will now have a cut-off date for interest payments of 60 months.

 

The Employer paid job training or continuing education exclusion of $5,250 will end in 2013 which means this benefit will now be taxed as regular income for the employee.

 

  • Simplified retirement savings

The Bush Tax Cuts introduced sweeping changes to retirement plans in general.

An in depth coverage of these changes is outside the scope of this document, the following are the high level changes.

Raised the pre-tax contribution limits for defined contribution plans and IRAs

Increased defined benefit compensation limits

Made non-qualified retirement plans more flexible

Created “catch-up” provisions for older workers

Created the ROTH 401(k)/403(b)

 

  • Estate and Gift Tax rules

EGTRRA made sweeping changes to the Wealth Transfer Taxes; the estate tax, generation skipping transfer (GST) tax, and gift tax. With the expiration of the Bush Tax cuts the unified credit exclusion reverts from $5,120,000 back to $1,000,000

The Maximum estate tax, gift tax and generation-skipping tax rate will rise from 45% back up to 55%.

The state estate tax credit will revert back to a deduction for state estate taxes

The gift tax rate was further reduced to 35% in 2010 this will revert back to 55%

 

In 2003 JGTRRA was passed which:

  • accelerated the cuts passed with EGTRRA
  • increased the exemption amount for AMT
  • lowered the tax rates for dividends and capital gains

People in the 15% tax bracket had their Capital gains tax rate reduced from 10% to 8% on qualified gains of property or stock. This will revert back to 10%.

 

Unemployment Benefits

The standard unemployment benefit lasts for 26 weeks. Over the last 4 years this has been extended through two programs: the Emergency Unemployment Compensation Program (EUC) and the Extended Benefits program. The EUC provided upto a total of 53 weeks of extended benefits and the Extended Benefits provided 13 to 20 weeks of additional unemployment compensation. When all is totaled, an individual could receive up to 99 weeks of unemployment compensation. At the end of this year the bulk of these extensions will end which will revert the unemployment benefit back down to the standard 26 weeks.

Doc Fix on Medicare

Each year congress votes to delay the Medicare Sustainable Growth Rate Formula (the “doc fix”) from going into effect. If this is not continued this year it will result in an immediate 27% cut to Medicare physician payments.

 

The above highlights should help you understand the issues being discussed in Washington and the potential impact they might have on your financial future. For more specific information regarding your unique financial situation I strongly recommend that you sit down with your Tax and Financial advisor to discuss any concerns you may have.

 

Comments are closed.