Now that the election is over the media has turned their full attention to the economy and "The Fiscal Cliff." The notion of anything having to deal with a cliff and the economy is probably not a good thing, but the media doesn't go into too much detail on what that actually means. This article is a primer on the fiscal cliff: what it means to nation, the markets, and to us individually.
On December 31st, 2012, a large swath of the federal income tax code is scheduled to expire. Among the expiring provisions are the 2001 and 2003 tax cuts enacted under President George W. Bush, a compromise on the estate tax, a "patch" in the Alternative Minimum Tax (AMT) to reduce its impact, the temporary 2% payroll tax holiday, increased business expensing and a package of miscellaneous tax deductions.
On January 1st, 2013, five taxes enacted as part of the Patient Protection and Affordable Care Act (PPACA), more commonly known as Obamacare- also takes effect.
To top it off, there is also scheduled to be $109 billion in reduced spending due to the failure of the "supercommitte" to reach consensus on budget reductions. And in late February, the US government will hit the debt ceiling, exhausting its ability to borrow to finance ongoing spending without an increase by Congress.
All together this "Taxmageddon" event could potentially reduce economic output by hundreds of billions of dollars and throw the fragile economy back into a recession.
Washington has already started working on dealing with the fiscal cliff before it happens, however their record on dealing with these types of events is less than stellar, so I'm not sure how much progress we can expect prior to January 1st.
Absent action prior to January 1st, many tax provisions would revert to pre-2001 law:
- The lowest income tax bracket of 10% would expire, reverting to 15%.
- The top four income tax brackets would see rate increases. The 25% bracket would rise to 28%, the 28% bracket would rise to 31%, the 33% bracket would rise to 36%, and the top bracket would rise from 35% to 39.6%.
- The tax on long-term capital gains would rise from a maximum of 15% to a maximum of 20%. Additional, a 3.8% capital gains tax on high-income individuals, enacted as part of PPACA, takes effect in 2013. The top capital gains tax rate would thus be 23.8%
The following is a great article by the National Association of Realtors that explains how real estate transactions will be impacted by the new tax.
2013 3.8% Tax Scenarios & Examples
- The tax on qualifed dividends would rise from 15% to ordinary wage tax rates. The top dividend tax rate would thus be 43.4% (39.6% plus 3.8%)
Estate tax increase
- The estate of an individual who dies on December 31, 2012, will pay a federal estate tax of 35% on anything above $5.12 million. If the individual dies the next day on January 1st, the estate will instead owe a 55% tax on anything above $1 million.
The sheer size of the fiscal cliff in scope, importance, and dollars signifies the uncertainty faced by American taxpayers. History suggests that Washington will once again duct-tape together another short-term extension and put off the hard choices, anything can happen.
