What does the fiscal cliff deal mean for me?

As most of you have no doubt heard by now, late New Years night Congress agreed to a deal to avert or at least postpone the “fiscal cliff” that has dominated our news for the last few weeks.fiscal cliff deal

If you haven’t been paying attention to the news lately, you might have missed the discussions about the fiscal cliff. In a nutshell it is the combination of the expiration of a number of tax cuts along with some enforced government spending cuts that were a part of the deal last year to raise the debt ceiling. All of these were scheduled to go into effect on Jan. 1, 2013. Some economists feared that if all of those provisions were allowed to stand the combined effect might cause the US economy to slip back into recession. In reality, I think it was more of a “fiscal hill” as opposed to a “fiscal cliff” as far as the economy goes. However, there is no doubt we would have all felt the pinch from the tax man when our January paychecks arrived.

So what does the deal reached by Congress really mean for the average American.

1. Payroll tax cuts allowed to expire

First the biggest thing that will impact the average American is the 2% payroll tax cut will be allowed to expire. Prior to 2009 there was a 6.2% social security payroll tax that most Americans paid. As we were struggling to escape the recession, one of the acts that President Obama put forth was to reduce that social security tax by 2% to 4.2%. The idea was to give Americans a little extra in their pay and hopefully stimulate spending. That 2% cut expired at the end of 2012 and it will not be renewed, so you can expect that FICA line to be a little larger on your paycheck in January. That means for most of us our taxes will go up a bit.

2. Unemployment benefits extended

Unemployment benefits for many were set to expire at the end of 2012. These have been extended by one year which should help those who have been unemployed for a long time.

3. Bush tax cuts for the middle and lower class

There were a number of tax breaks and credits that benefited the middle and lower class. Most of these were extended for 2013 which should soften the tax man’s blow for many of us.

4. Higher taxes for larger incomes

For those individuals making more than $400,000 or couples making more than $450,000, the tax rate was increased from 35% to 39.6%. For those under that amount, rates should remain basically unchanged.

5. Debt forgiveness on your primary residence

If you settle a debt for less than what was owed, the amount that is forgiven is considered taxable income. The exception to this has been debt on your primary residence. So if you were underwater on your mortgage and were able to negotiate a restructuring of the loan, or if you were involved in a short sale or foreclosure and the amount that you still owed was forgiven, that amount was not considered taxable income. That was really good news if you were tens of thousands of dollars in the hole on your mortgage. That exemption on your personal residence was set to expire, but it has now been extended.

6. Estate taxes

The amount of money you could inherit exempt from taxes was scheduled to decrease from $5,000,000 to $1,000,000, but the $5,000,000 exemption has been restored. The tax rate though on inheritances exceeding that was increased from 35% to 40%.

7. The “doctor fix”

Congress fixed a rule that would have resulted in a large cut in pay that doctors receive for services provided to medicare patients.

8. Capital gains and dividend taxes

Taxes on these items will remain the same unless you make over $200,000 as an individual or $250,000 as a couple. Those with incomes over 200,000 (250,000 for couples) will pay the current 15% capital gains tax plus a 3.8% tax designed to help fund Obamacare. For income earners over $400,000 ($450,000 for couples)  the rate will increase from 15% to 20% plus the 3.8% Obamacare tax.

9. Tax credits for college tuition

Some educational credits that were created by the 2009 stimulus package have been extended 5 years. This will help lower-income individuals seeking to better their education.

10. Dairy subsidies

There has been talk that we might see up to $7.00 a gallon for milk in the coming months because of some dairy industry subsidies that were set to expire. These were extended so we should not expect to see a dramatic increase in the price of milk and milk related products.

11. No raise for Congress

Lastly, they revoked the $900 a year pay raise for Congressional members that the President recently signed.

More of a band-aid than a solution

The bill passed by Congress is really more of a temporary band-aid than a real solution. They have not addressed the mandated budget cuts yet. They postponed that discussion for 2 months. So no doubt the fiscal cliff will be a continuing story into 2013. Also, many of the tax provisions are simply extensions of the existing rules, but eventually those extensions will expire and they will need to revisit these issues. Additionally, there is the issue of the debt ceiling that limits how much money the government is allowed to borrow. We are very close to that ceiling again so those discussions will need to be initiated soon.

And of course the main elephant in the room is the deficit and the national debt. Bottom line is that while this deal may provide resolutions for some of the tax questions in the short-term, Congress still has a lot of work ahead of it to address the root issues. I doubt that we have heard the last of the fiscal cliff.

For me the real takeaway from all of these discussions is that it makes it even more important that you work to payoff debt and build up your savings. The stronger you can position yourself financially, the better you will be able to weather whatever storms the economy sends your way.

 Have worries about the fiscal cliff affected your spending?

Photo credit: forki23 (creative commons)

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