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BY CRAIG A. SEVERANCE, CPA
For quite some time we have heard the ancient Mayan calendar predicted the End of the World on Dec. 21st, 2012. However, if you have listened to the media lately, it seems this dire event has now been moved to Jan. 1st, 2013 – the date of the dreaded Fiscal Cliff. Will the world really end on January 1st?
More Taxes and Less Spending. The Federal government is truly broke – currently borrowing 46% of every dollar it spends. To keep troops deployed worldwide and to keep funding Mom & Dad’s Social Security checks and Medicare, the government is now borrowing over $1 Trillion/yr. Increasingly, the Federal Reserve is creating these dollars out of thin air. We have a long way to go before the USA becomes Greece (where lenders are now running the government) or the Weimar Republic (wheelbarrows of money to buy a loaf of bread), but one of these fates awaits us unless we raise more revenues and cut spending. The election season is over, and “Reality Season” is kicking in. Both Republicans and Democrats now agree more taxes and less spending are needed.
Tax Increase on the Middle Class. The biggest tax break for the Middle Class now in effect is the 2% cut in Social Security taxes on wages and Self Employment Income. This recent tax cut is now adding 2% to take-home paychecks and self-employed business owners’ profits. While the media has focused on the partisan fight over the “other 2%” — the top 2% of earners who face an income tax rate hike on January 1st — neither party seems to be trying very hard to maintain the 2% payroll tax cut for the Middle Class. It would cost about $115 Billion/year to keep this in place, so, failing a new source of revenue like a Carbon Tax (a move supported by Exxon as it would be good for the natural gas industry) the payroll tax cut will likely expire on January 1st. There are not likely to be any other tax rate increases on the Middle Class – lately defined as the lower 98% of Americans. Neither party wants this – and if current tax rates do expire automatically on January 1st, a very urgent bill in the new Congress will be introduced to restore current tax rates for the 98%.
Retiree Programs Likely to Be Cut. Perhaps even more significant for the middle class are the expected cuts to Medicare and Social Security. Key Republicans are proposing Medicare eligibility be raised to age 67, and both parties are exploring cutting the annual costof- living increases for Social Security benefits. These changes would leave retirees poorer. However, without a new source of revenue, or perhaps cuts to military spending of the magnitude such as proposed by fiscal conservatives like Rep. Ron Paul, the money simply is not there to continue these retiree programs in the manner that was expected. Though workers gave up 15% of their earnings their entire working lives to fund these programs, it was as if we asked a spendthrift child to hold our money for us. Congress spent the money on unfunded wars and other profligacy. We Baby Boomers also simply had too few kids, and are living far too long, to keep the “entitlements” we expected to receive.
Tax Increases on High Income Earners. Because the Bush tax cuts expire January 1st, Congress only has to do what it does best – do nothing – for tax rates to automatically rise Jan. 1st on the wealthiest Americans, as desired by the President. Thus, unless a deal before January changes this, expect to see marginal tax rates on married couples’ taxable income (after deductions and exemptions) above around $220,000 to automatically increase from 33% to 36%, and above roughly $390,000 to increase from the current 35% to 39.6%. Longterm capital gains tax – probably just for high earners – will also likely go back to a 20% rate, and dividends may also end up capped at 20% if there is a deal. The fate of limits on exemptions, itemized deductions, AMT, and many other items of the tax code are far less certain. Finally, for the high income (e.g. married couples with modified adjusted gross income over $250,000) a new 3.8% Medicare tax on unearned income, and an additional 0.9% Medicare tax on earned income, will also take effect in 2013. While this new Medicare tax will help fund the Medicare program, it is understandably a big reason many with high incomes opposed “ObamaCare”.
End of the World? Those living on the tightest of margins may experience these tax law changes – particularly the end of the Payroll Tax holiday – as the End of their current family budget. For most of us, instead of a “cliff”, the effect will be more of a “step” down from the debt-fueled fantasy of recent years. For all, the changes ahead mean better tax and financial planning will surely be needed.