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The Fiscal Cliff Fix: What It Means For You


What was that fiscal cliff all about?

How does the fiscal cliff “fix” affect you?

Late last year, we heard a lot about the so-called “fiscal cliff” – a combination of spending cuts and tax hikes set to automatically take effect unless the parties in Washington came to some kind of compromise.

Groups of people relaxing and enjoying on a cliff

The scenario was bleak.

If politicians didn’t work something out, the automatic spending cuts and tax hikes together could have sent our still teetering economy figuratively over the edge.

What happened?

Nobody (well, almost nobody) wanted to go over the fiscal cliff. Politicians predictably made concessions just in the nick of time, and disaster was averted.

The legislation that resulted is known as the American Taxpayer Relief Act (ATRA).

Here’s what’s in the fiscal cliff fix:

  • The end of the temporary reduction in the social security payroll tax. Since 2010, the employee-paid portion of Social Security tax withheld from paychecks has been 4.2%. If your check seems smaller since Christmas, it’s because you’re now contributing 6.2% of your pay to social security, instead. That’s only a 2% difference in your pay, but if you’re on a tight budget, you’ll feel the difference.
  • Reinstatement of the “Bush tax cuts”. Without a deal, taxpayers would have lost a long list of tax breaks, from liberalized adoption credits to expanded education credits. Many of the breaks expired effective 2012, but were reinstated retroactively.
  • Higher taxes for high-income taxpayers. If your taxable income is over $400,000 ($450,000 if you file jointly), your top tax rate will be higher in 2013 – as high as 39.6%. Your marginal tax rate on dividends and long-term capital gains increased from 15% to 20%. (For most taxpayers, the top rate on dividends and long-term capital gains is still 15%.) High-income taxpayers will also find their exemptions and deductions limited, beginning in 2013.
  • Other changes, including a permanent fix to the alternative minimum tax problem and extension of a number of corporate tax breaks.

How does this affect me?

Other than the decrease in your take-home pay from the end of the temporary payroll tax reduction, which your employer calculated for you, you probably won’t notice anything different.

If your income is in the upper brackets, you will pay more in tax than you would have without the tax hikes.

However, the change is not nearly as drastic as it would have been without the “fix”.

What do I need to do?

If you are self-employed and you make estimated quarterly tax payments, make sure you’re setting aside enough money to cover the additional 2% in social security tax.

Likewise, if you are a high-income taxpayer, you should make sure you are having enough money withheld or make sufficient estimated tax payments to cover your tax liability.

The tax withholding schedules have changed to reflect the new rates, so your employer should be taking more out of your check. However, it’s always a good idea to double-check.

Otherwise, the big news is that very little is new.

Did you notice the temporary payroll tax reduction more when it was first put in place and your paycheck got a boost, or when it was taken away and your take-home pay went down?

Photo credit: larskflem via photopin cc

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