The Fiscal Cliff: What Is It?
By now, we’ve all heard about the “fiscal cliff,” a term used to describe the “perfect storm” of expiring tax cuts and new taxes set to take effect in 2013 if Congress and the White House do not agree on a way to avert it. When combined with government spending cuts required as part of the debt ceiling deal that raised our nation’s borrowing limit in 2011, many predict that, if not quickly modified, this “fiscal cliff” could send our economy into another recession.
What Will Change?
If all of the terms are enforced, your taxes will rise. Among the laws set to change at midnight on December 31, 2012, are:
– The top income tax bracket will rise from 35% to 39.6%.
– The top capital gains rate will rise from 15% to 20%.
– Dividends will no longer be taxed at 15%; they will be taxed as ordinary income.
– The temporary FICA payroll tax reduction would expire and increase the rate to 6.2% from 4.2%.
– Estates worth more than $1 million in 2013 will be taxed at 55 %, down from $5.12 million at 35% in
– The deduction of medical expenses will now be subject to exceeding 10% of your Adjusted Gross
Income, up from the current 7.5%.
– Several provisions that benefit the lower classes — most notably the increased child tax and earned
income credits and the expanded education credits — are slated to expire.
– Starting in 2013, taxpayers earning more than $250,000 will pay an additional 0.9% tax on their wages
and 3.8% on their unearned income (interest, dividends, capital gains.)
– Numerous spending cuts agreed upon as part of the debt ceiling deal of 2011 will begin to go into
– According to Barron’s, over 1,000 government programs – including the defense budget and Medicare
are in line for “deep, automatic cuts.”
Yearend Tax Moves To Consider
– Sell appreciated assets (stocks, mutual funds, etc.) in 2012 to recognize long-term capital gains at the
15 percent tax rate and avoid the 3.8 percent Medicare surtax beginning in 2013.
– Invest in municipal bonds. Higher tax rates will increase tax equivalent yields on municipal bonds.
– Additionally, affluent investors may want to consider an investment in municipal bonds since the interest
on municipal bonds is not subject to the new Medicare investment income surtax.
– Schedule elective medical procedures in 2012 if they will entail significant out-of-pocket expenses
because the ability to deduct these expenses becomes even more difficult in 2013.
– If your combined household income is expected to be over $250,000 in 2013, try to pull all yearend
bonuses and consulting fees into 2012 to avoid the new taxes you’ll be subject to in 2013.
– If you are planning to sell your business and expect to receive a significant capital gain on the sale, you
should do everything you can to close the sale on or before Dec. 31, 2012 to avoid the tax increase on
capital gains as well as the new Medicare tax on investment income.
The oncoming fiscal cliff is a concern for taxpayers since the highly partisan nature of the current political environment could make a compromise difficult to reach. This problem isn’t new: lawmakers have had three years to address this issue, but Congress – mired in political gridlock – has largely put off the search for a solution rather than seeking to solve the problem directly. Republicans want to cut spending and avoid raising taxes, while Democrats are looking for a combination of spending cuts and tax increases. Although both parties want to avoid the fiscal cliff, compromise is seen as being difficult to achieve. The most likely outcome is another set of stop-gap measures that would delay a more permanent policy change until 2013 or later.
This memorandum is not intended to provide tax advice, but is intended as a general description of federal tax and possible outcomes. This memorandum contains opinions of the author and should not be used by any person or entity for the purpose of making financial or tax decisions or avoiding or reducing taxes or penalties that may be imposed by the Internal Revenue Service. Please consult your tax advisor before taking any actions.