Fiscial Cliff Explained - Fiscal Policy Review

Dec 28, 2012 | by Franck Cushner, CFP®

The Fiscal cliff” amounts to $607 billion in federal spending cuts and tax increases scheduled to take effect January 2013, unless an agreement is reached between the administration and Congress.


The “fiscal cliff” affects more than just individual tax rates, it also threatens to eliminate favorable deductions as well as affect estate-planning exemptions.


The Federal Reserve has also expressed concern, as Fed officials said the looming fiscal cliff poses yet another risk to economic expansion. Fed officials said businesses have reported, “delaying or cutting back on hiring and capital spending” because of the uncertainty.


Another item of contention has been the debt ceiling, with the administration proposing to make it difficult for Congress to block increases in the federal debt ceiling. The debt ceiling has been raised 40 times in the past 30 years, and currently stands at $16.394 trillion. As of November 28th, U.S. debt was $16.268 trillion. The Congressional Budget Office estimates that the government has until February or March 2013 to continue borrowing, which will then need a debt ceiling increase.


According to a National Federation of Independent Business (NFIB) small business survey, 75 percent of small businesses are organized as pass-through entities meaning they pay taxes on their business income at the individual rate. Additionally, 54 percent of the private sector workforce is employed by pass-through entities.

How the “fiscal cliff” affects taxpayers varies of course from individual to individual. Below are those items either expiring or up for debate and, possibly affecting a substantial portion of taxpayers nationwide:


Individual Income Tax

The 15 percent bracket would become the lowest tax rate, up from 10 percent. The top marginal rate would rise from 35% to 39.6%.

Capital Gains

The capital gains rate on assets held longer than a year would increase to 20% from 15% for middle & upper income taxpayers and rise to 10% from zero for those with lower incomes.



Dividends would be taxed as ordinary income rather than at the same rate as capital gains.


Estate Tax

The maximum rate on taxable estates would rise to 55 percent from 35 percent. The maximum estate size exempt from tax would fall to $1 million from $5 million.


Alternative Minimum Tax

An estimated 31 million additional taxpayers would be required to pay alternative minimum tax (AMT), where 4 million were subject to it in 2011.


Social Security Payroll Tax

The employee share of the Social Security payroll tax would revert to 6.2 percent from 4.2 percent.


Child Tax Credit

The per-child tax credit would revert to $500 from its current level of $1,000 and would cease to be refundable.

Expansions of the earned income tax credit, the dependent care credit and the adoption credit would expire.




Sources: NFIB, CBO, US Labor Dept, Federal Reserve

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