What is going to happen on the 1st of January 2013 if the fiscal cliff is not resolved by Congress? How is the average taxpayer going to be affected by the fiscal cliff tax changes? The truth of the matter is that the middle class citizens of America are going to see their federal tax bills increase by thousands of dollars. There is also one critical mistake that we are all making that will make the fiscal cliff even worse for every person if we do not change our ways. I’m not talking about the things that are going on in Washington. There is a problem on Main Street in every city with the fiscal cliff as well.
The fiscal cliff refers to the President Bush era tax cuts were enacted in the early 2000s that are expected to expire this year. We have been kicking the can down the street for years and extending the expiration, but this year they are coming due unless Congress acts. Having these tax cuts expire will have a tremendous impact on every working American.
The Obama Administration has proposed eliminating $150 billion worth of tax breaks over the next ten years as part of his administration’s negotiations as a way to avert the dangerous fiscal cliff that the country faces at the first of the year. The tax cuts include deductions and tax breaks that are currently in place for fossil fuel companies, the valuation of company’s inventory levels, and changes in the tax rates on low capital-gains for some types of investments and real estate.
Here are some of the ways that you will be affected and what you can expect. There is also one critical mistake that we are all ignoring too that will have a very devastating impact on your wallet if not addressed.
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Kicking The Can Down The Road
In December 2010, the United States Congress passed the Job Creation Act of 2010 which also addressed tax relief and unemployment insurance. The law also extended the Bush era tax cuts for an extra two years. It only applied patchwork solutions and exemptions to the Alternative Minimum Tax (AMT). So, can we expect Congress to continue to kick the can down the road and not pass substantial legislation to fix the problem? It is indeed a very real possibility. We could see them only fixing the fiscal cliff problem partially and passing new laws that address the problem for the next few years ago. Now is the time with the lull in the election cycle to tackle this and other hard problems that need bipartisan support.
Lose Thousands With Employee Tax
With the looming fiscal cliff, there will be an expiration of the 2% Social Security payroll tax cut. Typically the Social Security payroll tax had been 6.1% in past years before President Bush lowered it to 4% that employees have deducted automatically from their paychecks. On the 1st of January, we are all likely to see the tax revert to the 6.1% level even if Congress addresses other issues related to the fiscal cliff. So, what will that mean to you? It will cost you thousands of dollars. For example, someone who earns $50,000 per year can expect to cough up an extra $40 or so every two weeks from their paychecks. That of course will equate to about $960 that won’t find its way home in your paycheck each year that you have grown accustom to having.
Lifestyle Creep Can Be The Big Disaster Looming
Many lawmakers and think tank experts consider the rollback of the Social Security payroll tax to 6.1% is almost inevitable. The likelihood of Congress letting this tax increase revert back to previous levels is looking higher and higher. So, the real question is what will American families do about losing almost $50 out of each paycheck? The problem is that most people simply spent the increase in our take home pay that President Bush provided years ago when the tax was reduced. Many people that you talk to on the street or in your workplace did not even realize that we received a relative 2% pay raise when President Bush enacted the tax holiday. We simply went about our business and spent the money that was pay to us in our paychecks without even realizing the change. We have let our lifestyles increase by $50 per month since we simply spent that money instead of saving it. No one adjusted their household monthly budget to account for the increase in $50 in spendable income every month. How often do you update your budget?
You may not think that $50 per month is a big deal, but it can lead to other issues if it is allowed to compound. It has the potential of throwing off your monthly household budget if you are very tight without much discretionary spending allocated. You could see a rise in credit card spending in order to keep up with your normal spending before the tax reverts back to 6.1%. While the possibility and danger are relatively low with this one instance, it could quickly expound should the middle class be hit with other types of tax increases associated with the fiscal cliff.
The Bush era tax cuts that were enacted in 2001 and extended in 2010 are set to expire at the end of 2012. But, what does that mean for investors? What does that mean for the average American? Many tax benefits that were a boon to the middle class will expire if not fixed by Congress. This could have a devastating effect on your finances. Additionally, if you do not change your spending habits when the new tax rates increase, then you will quickly find yourself in a world of hurt.
List above is just one small piece of this fiscal cliff that is looming and set to expire after the New Year. There are other aspects I did not address such as Alternative Minimum Tax (AMT) changes, changes to the length of unemployment insurance benefits, Medicare changes, and others. Like the Social Security payroll tax, these changes may not be catastrophic when looked at by themselves, but they have the potential to be severely damaging if they are compounded together.
What about you? Are you worried about the fiscal cliff? Do you have faith that our lawmakers will fix the issue, or do you think that they will punt it and continue to kick the can down the road?