CPAs review major pieces of 'economic puzzle' ahead
The term "fiscal cliff" has become a popular phrase among politicians and pundits over the past several months, but what does it mean? If the United States goes over it, will you be affected?
The so-called fiscal cliff actually refers to two separate sets of economic events that will take place.
If politicians in Washington fail to come to an agreement, a popular set of tax cuts will expire. At the same time, a plan for severe government budget cuts will begin to be phased in. Over the long term, the combined effect would be significant.
However, it is also highly unlikely that all of the factors that would create a worst-case scenario for you or the economy will play out. What we are left with, then, is a high level of uncertainty about when and how political forces in Washington will address these matters.
Some are predicting dire results. In reality, any effect on the overall economy would take place very slowly.
Taxpayers could experience an unpleasant surprise when they see their paychecks, say the tax experts at the Minnesota Society of Certified Public Accountants (CPAs). However, it remains very likely that some kind of political settlement will be reached.
Here's a description of the major pieces of the economic puzzle that politicians are working on:
What may be going up?
If Congress does nothing, some popular tax-cut provisions will expire. Some of these tax cuts were originally passed with "sunset" provisions so that they did not appear to increase the national deficit as much as they would have otherwise.
Other tax cuts were passed in the wake of the recession that started in 2008. Still other tax matters pertaining to the "the cliff" involve long-standing issues that have been addressed annually by Congress for years:
Expiration of the 2001/2003/2010 tax cuts.
This legislation, which you hear referred to as the "Bush tax cuts," expired on Dec. 31, raising all income tax rates (the top income tax bracket will go from 35 to 39.6 percent), as well as rates on estates and capital gains.
The AMT patch.
Unlike the regular income tax, the alternative minimum tax (AMT) is not indexed for inflation. Thus, more taxpayers owe AMT as that liability rises relative to regular tax liability. As a result, Congress has had to enact a fix to the AMT by periodically increasing the exemption amounts.
The current exemption amounts are set to expire on Dec. 31. If not adjusted, the AMT will automatically apply to many more taxpayers.
Payroll tax cut.
Originally passed to help push the country out of the 2008 recession, the Social Security payroll tax holiday expired Dec. 31, raising the rate from 4.2 to 6.2 percent. For the past two years, this provision has been providing workers with an average of about $1,000 a year in extra cash.
Several breaks for businesses, such as the Research and Experimentation tax credit, which are typically enacted retroactively, are due to sunset at year's end.
Affordable Care Act taxes.
Some provisions in the Affordable Care Act (health care legislation), including additional taxes on high-income earners, are set to take effect in January.
What may be going down?
In conjunction with the tax hikes, spending cuts affecting financing for many federal domestic programs and the military will begin to phase in. Additional cuts include:
Extended unemployment benefits. The eligibility to begin receiving federal unemployment benefits, last extended in February, will expire at year's end.
Medicare "doc fix." Like the AMT patch, Medicare rates have never been "indexed" to rise automatically with incomes. As a result, Congress has to pass an annual "fix" to Medicare reimbursement rates.
If it does not, the rates at which Medicare pays physicians will decrease by nearly 30 percent as of Dec. 31.
Budget Control Act. The automatic spending cuts legislated by the Budget Control Act of 2011 - more commonly referred to in the press as "budget sequestration," will go into effect Jan. 2.
Half of the scheduled annual cuts ($109 billion per year from 2013-2021) will come directly from the national defense budget, half from non-defense.
The impact on you
The overall economic impact of the tax increases and spending cuts is estimated to be $500 billion.
If the United States were to go over the proverbial fiscal cliff, taxes would rise for nearly every taxpayer and many businesses.
Middle-income families would have to pay an average of about $2,000 more next year, according to calculations by the nonpartisan Tax Policy Center.
What we are seeing is some of the reality of living in a democracy, and the uncertainty that can occur when politics are involved. We've heard a lot about worst-case scenarios, but it is very unlikely that any of them will occur.
What we will see is a lot of political theater. Some measures like the payroll tax deduction may end. But overall, there will be some kind of agreement.
We just don't know exactly what it will look like yet.