How Will the Fiscal Cliff Affect Paychecks?

In the short term, employees may not see much of an impact but a bigger hit could come down the road.

If the country goes over the "fiscal cliff," how will your paycheck be affected? With just one day to go before fiscal cliff deadline, employees and employers are left to wonder what impact the lack of a tax legislation agreement between the White House and Congress will have.

Employees will notice an immediate reduction in take home pay due to the expiration of the 4.2 percent Social Security tax rate on Dec. 31. The tax rate will revert to 6.2 percent in 2013.

Other changes may not be noticeable for a few weeks.

In the short term, the IRS will allow employers to continue withholding at the 2012 rates. However, should those rates change due to a failure in negotiations in Washington, any deficit in collection will be made up later in the year, CNBC reports.

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  • ‘Taxmageddon’: $500 Billion Tax Increase Approaching

A Tax Policy Center (TPC) analysis predicts taxes will rise by an average of $3,500 per household -- or $500 billion overall in 2013 -- if the existing tax cuts are allowed to expire. 

Almost 90 percent of Americans would experience a tax increase, the TPC report states. Most of that increase would be a direct result of the expiration of the temporary cut in Social Security taxes and the end of the 2001 and 2003 Bush-era tax cuts.

"Average marginal tax rates would increase by 5 percentage points on labor income, by 7 points on capital gains, and by more than 20 points on dividends," the report warns.

Another potential problem for tens of millions of taxpayers is the failure of Congress to pass a "patch" for the Alternative Minimum Tax (AMT). The AMT was initially passed to make sure higher income earners paid their "fair" share of taxes. The problem lies in the fact that the income level at which the AMT comes into play has never been indexed for inflation. Instead, Congress regularly passes a "patch" to keep the AMT in line with its original intent. The last patch expired on Dec. 31, 2011. If Congress does not act in time for the 2012 tax filing season, the Tax Institute at H&R Block estimates a family earning $85,000 with two children in college could go from a tax refund of $1,056 to owing $1,400.

But wait, there's more bad news for your bottom line.

Numerous tax breaks are set to expire if no action is taken and several other new taxes related to the Affordable Care Act (also known as Obamacare) are set to go into effect:

  • A new medical device tax will impose a 2.3 percent excise tax on every medical device valued over $100. As the American for Tax Reform website explains, "In addition to killing small business jobs and impacting research and development budgets, this will increase the cost of your health care – making everything from pacemakers to artificial hips more expensive."
  • Flexible Spending Accounts (FSAs) will be capped at $2,500. The Americans for Tax Reform website notes this cap will be “particularly cruel and onerous” for parents of special needs children who currently take advantage of the unlimited FSA to fund special needs education expenses.
  • The Obamacare investment surtax will result in the capital gains rate increasing from 15 to 23.8 percent in 2013 and the dividends tax will rise from 15 to 43.3 percent.
  • The threshold for medical itemized deductions will increase from expenses exceeding 7.5 percent of adjusted gross income to 10 percent of adjusted gross income.
  • The Medicare payroll tax will increase from 2.9 to 3.8 percent for all wages and profits exceeding $200,000 for individuals and $250,000 for married couples.

While the impact on family budgets could be profound, the broader economic implications are also cause for concern. ABC News reports the spending cuts and tax increases could, "stifle the US economic recovery and send the country back into recession, spelling bad news for the global economy as well."

Do you think political leaders will be able to reach an agreement in time to avert a fiscal disaster? Let us know in the comments.


M.K. OSBORNE December 31, 2012 at 10:54 PM
Tammy Osier January 02, 2013 at 12:33 AM
So much for the promise that the middle class won't be affected. Some of us knew this already. NOsurprise here. I have a feeling this will be a year of many I told you so's... No matter what decisions they make on capitol hill, it won't put much of a dent in this. They are still of the mindset that to spend more money, somehow you fix it. NOT! It's like the definition of insanity where "insanity is doing the same thing over and over expecting a different result."
Tammy Osier January 02, 2013 at 01:19 AM
How in the world do liberals explain this? The current administration knew this while campaigning (translate: lied top get elected). . I'm sure there will be some excuse. Oh, never mind, I notice how silent it is here. Can't explain it. That's why. When tax cuts expire, taxes go UP. "The budget deal passed by the U.S. Senate today would raise taxes on 77.1 percent of U.S. households, mostly because of the expiration of a payroll tax cut, according to preliminary estimates from the nonpartisan Tax Policy Center in Washington. More than 80 percent of households with incomes between $50,000 and $200,000 would pay higher taxes. Among the households facing higher taxes, the average increase would be $1,635, the policy center said. A 2 percent payroll tax cut, enacted during the economic slowdown, is being allowed to expire as of yesterday."
R++ One of the Famous Dacula Crew January 02, 2013 at 04:13 AM
Gee M.K. thanks for that video. That means we won’t have to WORRY until we get to 24 TRILLION, we don't go over till 25 TRILLION - there’s PLENTY of time left to ignore it!! Let’s just RAISE spending and call it a New Year…
R++ One of the Famous Dacula Crew January 02, 2013 at 04:16 AM
Tax cuts are temporary; tax (fee/penalties) increases are FOREVER!


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