This article was last updated on December 14
[Updated Jan 2013] Congress and the Obama administration have reached an agreement that will avert a significant portion of the fiscal cliff and its associated impacts on your pay check and taxes next year. The passed legislation would increase tax revenue by $620 billion and only cut spending by $15 billion because the planned sequestration/spending cuts will be delayed by two months. The Tax Policy Center estimated around 77% of American households would see a tax increase in 2013 compared to their 2012 tax levels. Here are key aspects of the deal:
Unemployment Benefits Extension
Unemployment benefits have been extended into 2013. This means newly unemployed and those with time left on their unemployment benefits will continue to receive aid in 2013. However the current deal does not expand the UI benefit duration (detailed here), meaning those who have already exceeded the maximum allowable benefits (up to 73 weeks in some states) will NOT be able to receive additional benefits.
Payroll Tax Credit
The 2 percent cut in Americans’ payroll taxes, effective in 2011 and 2012, expired on December 31st 2012. This stimulus driven tax credit did not receive much support for an extension from either party or the President, and was a casualty of the fiscal cliff deal. See the up to $2,200 impact on your paycheck with the expiry of this credit.
Federal Income Taxes
2013 marginal tax rates will rise to Clinton-era levels (39.6%) on incomes above $450,000/$400,000 (married/single) vs the $250,000/$200,000 originally proposed by President Obama. Current 2012 tax rates will be extended for all other income levels, though tax brackets may rise due to inflation. The deal also would reinstate limits on personal exemptions and itemized deductions for couples making more than $300,000 (singles making more than $250,000)
Investment, Estate and Capital Gain Taxes
The deal also contains provisions to raise top tax rates on investment income to 20% from 15% for higher income households. It also raises the estate tax top rate to 40% from 35%. Estates would receive a more-than $5 million exemption. This is up from the 35% that applies now to those over $5.12 million, but is still lower than the 45% rate and $3.5 millon exemption that the President wanted. The exemption would be indexed for inflation. The alternative minimum tax (AMT) would also be permanently fixed to prevent it from expanding to more households and Congress having to apply a patch every year.
Government Pay (2013 GS Pay Scale)
Under the deal the current pay freeze for government workers on the GS scale will be lifted, but the existing pay freeze for members of Congress will continue.
Other Tax Credits and Breaks
Also included in the Biden-McConnell deal as it is being called is a five-year extension of existing tax breaks that benefit lower income families. This includes the American Opportunity Education Tax Credit (AOTC) for college tuition, expanded earned income tax credit (EITC)
The compromise would also prevent a cut in Medicare payments to doctors for one year, which may been have been cut by up to 30% had no deal been reached.
Spending Cuts and Tax Revenue
The deal pays for delaying the spending (sequester) cuts with new taxes that include a $12 billion revenue generating provision that allows workers with employer sponsored 401(k) plans to roll over their 401(k) assets into a Roth IRA plan (as is currently allowed for IRA plans). This roll over would trigger an up front tax liability on any gains in their 401(k) plan. The benefit for investors would be that disbursements from Roth plans in retirement are tax free.
[Update Dec 28th 2012] Sources within both parties involved in negotiations to prevent the nation falling off the fiscal cliff are saying that a compromise may be imminent. Details are limited but the general framework revolves around permitting taxes to rise to Clinton-era levels on incomes above $400,000 (vs the $250,000 currently being proposed by Obama). A compromise deal would also extend unemployment benefits and delay the imposition of mandated cuts to defense and other discretionary spending. No word on entitlement cuts, but it is likely that any significant changes to social security, medicare or the tax code will only take place next year when the new Congress is in session.
With the latest failure of House Speaker Boehner to get his Plan B passed, which included tax hikes for the super-wealthy, it looks like the country (and the world) is about to fall over the so called fiscal cliff. The graphic to the right, from the Washington Post, provides a nice visual summary of the impacts (by income quartile) of falling off the cliff.
With Speaker Boehner unable to get even his own party on board to a Republican proposed plan, his negotiating power and reputation has been immeasurably weakened. In fact, he has given up on a solution to the pending financial calamity with his office issuing a statement that said, “The House did not take up the tax measure today because it did not have sufficient support from our members to pass. Now it is up to the president to work with [Senate Majority leader] Harry Reid on legislation to avert the fiscal cliff.”
Only a handful of days remain until the new year, when more than $500 billion in automatic tax increases and spending cuts will begin to take effect, undermining business and consumer confidence and potentially send the economy back into a recession
What is the Fiscal Cliff and Impacts of Falling Off? It is basically a set of tax hikes and spending cuts that will go into effect if Congress and the re-elected Obama administration don’t compromise and get their act together. If we go over the “fiscal cliff” at the start of 2013, federal income tax rates will return to the higher pre-Bush tax cut era levels (see potential 2013 rates), the FICA payroll tax credit holiday disappears, federal long-term unemployment benefits go away and people who lose their jobs in 2013 will only be entitled to 26 weeks of state unemployment benefits.
Medicare reimbursements to doctors will also get cut and because the debt ceiling stays the same the government will be forced into taking sequestration measures which means across-the-board government spending cuts, including a $55 billion (9%) cut to the defense budget.
Markets were clearly not happy with the performance of Congress and the Obama administration to reach a deal and have fallen sharply today.