What does falling off the “fiscal cliff” really mean?

Ok, so you heard it in the news, you saw it in the newspaper, but what is the “fiscal cliff?” No, it doesn’t mean you will actually fall off the cliff at year-end, but if Congress doesn’t act soon, your pocketbook may feel the dive.

What is the Fiscal Cliff?

While it is not really clear who coined the phrase the “fiscal cliff,” it is however, referred to the expiration of tax cuts, such as the “Bush era tax cuts.” During 2001, George Bush implemented the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) that provided a series of tax cuts to reduce federal income tax rates for all individuals.

Key legislative pieces were the reduction of income and capital gain taxes, the creation of the 10% income tax bracket, and a reduction in estate tax rates. In addition, it also removed the “marriage penalty,” by allowing married filing joint taxpayers to claim a standard deduction equal to twice the amount available to single taxpayers.

Congress has extended the majority of the so-called “Bush era tax cuts” through the implementation of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. However, these tax cuts are scheduled to expire on December 31, 2012.

The Payroll Tax Holiday

Also, many Americans may not be aware, but during the last two years, they have enjoyed a small “pay raise.” During 2010, Congress implemented the payroll tax holiday to temporarily reduce payroll taxes. Originally scheduled to expire in 2011, Congress has extended the holiday to December 31, 2012. Currently, employees’ payroll taxes have decreased from 6.2% to 4.2%, and self-employed individuals’ taxes have also decreased from 12.4% to 10.4%.

What if Congress fails to act?

If Congress doesn’t reach an agreement, you can expect some of the following:

  • Employees and self-employed individuals can expect an increase in taxes;
  • Capital gain rates are expected to rise to 20%;
  • Married individuals will no longer be able to take advantage of the increase standard deduction equaled to twice the amount of single taxpayers;
  • The 10% tax bracket will be eliminated for low-income taxpayers; and
  • High-income taxpayers can expect to pay up to 39.6.

For more information, check out “Year-end tax planning during uncertain times” and “Tax laws scheduled to expire.”

Remember: your choice, your future!

Kemberley Washington is a certified public accountant and a business professor. Follow her on Twitter, like Kemberley.com on Facebook!

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4 thoughts on “What does falling off the “fiscal cliff” really mean?

  1. The other half of the fiscal cliff are Govt spending cuts. From an economic perspective, although the combination of tax increases and spending cuts will reduce government debt they are not appropriate methods to stimulate the economy. Going over the fiscal cliff can take us back into a recession.

    • You are correct, unemployment benefits are also at risk. Some argue, if the government does not make a move it can put the economy into a a recession, however others argue, the tax cuts and excessive spending can also put the economy into a recession. There has to be a middle ground. We have to see what happens in the next few days.

      Thanks for reading.

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