Something About a “Fiscal Cliff”

Something About a “Fiscal Cliff”

By David DuWaldt

November 19, 2012

Walking off a cliffNow that the election is over, the President and members of Congress are, once again, having discussions about the fiscal cliff which the United States will soon face unless new legislation is passed. The term, “fiscal cliff,” was first introduced by Federal Reserve Chairman, Ben Bernanke, to describe changes that are scheduled to take place after 2012. 

Beginning in January of 2013, certain provisions of the Budget Control Act of 2011 will take effect and bring about a substantial reduction in government spending. At the same time, the Bush-era tax cuts are scheduled to expire. So what does this mean for the economy? Many economists believe that increases in tax and reductions in government spending will have a negative effect upon an economy that is still trying to recover.

The Budget Control Act of 2011 became law back on August 2, 2011 and brought a conclusion to the debt-ceiling crisis of 2011. Although the federal debt ceiling was increased, provisions were included in this legislation that automatically requires a reduction in federal spending. A few days after this legislation was signed by President Obama, Standard & Poor’s downgraded the nation’s credit rating from “AAA” to “AA+” which led to some concerns about an increase in interest rates on U.S. Treasury obligations. 

With respect to the revenue side of the federal government, the Bush-era tax cuts are currently scheduled to expire at the end of this year. In addition, provisions of more recent tax legislation are set to expire this year. Below is a list of some of the significant changes, assuming that no new legislation is passed:

  • The employee payroll tax holiday, which provided a reduction in the Social Security tax withholding rate from 6.2% to 4.2%, ends this year.
  • Income tax rates move up for individuals in 2013. For 2012 and earlier years, the top rate on ordinary income was at 35%. Beginning in 2013, the top rate on ordinary income will move up to 39.6%.
  • Long-term capital gains and qualifying dividends for individuals in 2012 and earlier years were subject to a tax rate of up to 15%. Beginning in 2013, the top rate on long-term capital gains will move up to 20% and dividends will be treated as ordinary income. 
  • For businesses, the 50% bonus depreciation for most new property will expire this year.
  • For small businesses, the IRC Section 179 expense amount will decline from $139,000 this year to $25,000 in 2013.

Although some legislation was introduced earlier this year, at this moment we do not have a 2012 “AMT patch.” This term refers to the exemption amount used for computing the Alternative Minimum Tax.  Without an AMT patch, many individual taxpayers will witness the tax effect when they file their 2012 federal income tax return. 

Back in December 2010, legislation was passed that changed the federal estate and gift tax levels. For 2012, the estate and gift tax exemption is $5.12 million and the top tax rate is 35%. Beginning in 2013, the estate and gift tax exemption will move down to $1 million and the top tax rate moves back up to 55%. 

As described in my prior article of October 29, new Medicare taxes will be imposed on certain types of income for applicable taxpayers. Although this tax will not affect individuals with relatively low income or for those receiving most of their income from retirement plans, the new Medicare taxes may still have an effect upon the economy. 

Based on the foregoing and subject to the facts and circumstances, it is wise to complete certain transactions before the end of 2012. It will be interesting to observe federal legislative activities for the remainder of this year for avoiding the fiscal cliff.

Posted by David DuWaldt.


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