What the Fiscal Cliff Deal Means For You

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Capping several days of frantic year-end negotiations, Congress passed compromise legislation on New Year’s Day to head off the dreaded “fiscal cliff,” an accidental convergence of tax increases and automatic spending cuts that economists feared would throw the country into another recession.  Yesterday, President Obama signed the legislation into law.

What does this mean for you?  Broadly, it means that income taxes for the vast majority of Americans won’t go up, though Social Security payroll taxes and inheritance taxes on large estates will rise. The below list provides further detail on what this deal means for your finances.  (The points referenced were originally noted in this AP article.)

  • Middle-class families won’t see their income tax rates go up.
    It extends decade-old tax cuts on incomes up to $400,000 for individuals and $450,000 for couples; the tax on earnings above that amount goes from 35 percent to 39.6 percent.

 

  • Some deductions and exemptions are capped.
    It caps itemized deductions and phases out the personal exemption for taxpayers making more than $250,000, or $300,000 for couples.

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  • Estate tax rates rise.
    It raises the top estate tax from 35 percent to 40 percent on estates valued at over $5 million for individual estates and $10 million for family estates.

 

  • Capital gains tax rates rise.
    It increases the tax rate from 15 percent to 20 percent on capital gains and dividends for individuals earning $400,000 or families earning $450,000.

 

  • The AMT may impact fewer middle class families.
    It indexes for inflation the alternative minimum tax. The goal is to prevent inflation from making more middle-income Americans subject to an average of $3,000 more in taxes from a tax that was intended to prevent the wealthy from paying their share.

 

  • Unemployment benefits are extended.
    It extends for a year payments to the long-term unemployed.

 

  • Payroll taxes rise.
    It did not extend a 2-percentage-point cut in the Social Security payroll tax, which will mean higher payroll taxes for most working Americans.

 

The deal also delays two things: some Medicare cuts and automatic spending cuts.  It delays for a year a 27 percent cut in Medicare payments to doctors; lawmakers feared that cuts would have encouraged more doctors to drop Medicare patients. It also delays for two months the bulk of automatic spending cuts that were scheduled to occur on Jan. 1. Economists feared that the spending cuts, coupled with across-the-board income tax increases, would have put the country back into recession and cost thousands of jobs.

Like many other observers, Maclyn Clouse, a professor of finance at the University of Denver’s Daniels College of Business was happy to see a compromise, but he expressed surprise that the agreement didn’t resolve more of the fiscal crisis.

“I didn’t expect it to solve all the problems, but all this really is is a tax rate change. The rest of it is just kicking the can down the road,” he said, referring to the deferred decisions on the spending cuts.

The dramatic cuts in spending were a more pressing issue than the tax hike on the wealthy, he said, and those cuts are still on the table, with the potential to lead to widespread layoffs and reduced government contracts. “Now they have to do it (negotiate the spending cuts) in the context of negotiating what they’re going to do with the debt ceiling,” Clouse said.

 

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