How the fiscal cliff deal will hit your taxes

9:30 AM cliff, fiscal, taxes No Comments

John W. Schoen , NBC News

Yes, your taxes are going up. But you dodged a much bigger bullet.

Those increases are relatively modest compared to what the fiscal cliff would have imposed, however.The last-minute ‘fiscal cliff’ deal to reverse Congress’ ruinous, self-inflicted package of federal tax increases and spending cuts will raise the average American household’s tax bill by $1,250 this year, or about $25 a week.


For most Americans, the biggest impact will come from the expiration of a two-year payroll tax “holiday” enacted two years ago to boost the economy. That tax break amounted to two percent of wages.

“For a lot of people the increased withholding from payroll tax expiration will be significant and they’ll really see that and feel that as a legitimate tax increase,” said Joseph Rosenberg, an analyst at the Tax Policy Center. “But there was a lot of tax relief that has been extended."

Without a deal, taxes would have jumped by more than $500 billion in 2013 as almost every tax cut enacted since 2001 was set to expire. That would have cost the average household almost $3,500 per year, or about $67 a week, according to the Tax Policy Center.

The deal hammered out in the waning days of 2012 preserves most of those tax cuts – except on the very top of the income ladder. Even then, the final deal raised the definition of “wealthy” from $250,000 for couples ($200,000 for individuals) to $450,000 for couples ($400,000 for individuals). Those thresholds also apply to many small businesses that pay taxes at individual rates.

The averages, though, apply to a statistically tiny group of people who fall in the middle of every variable in the new law. Thanks to dozens of provisions that will hit different households making the same income in different ways, your overall tax bill will almost certainly change by more – or less – than $25 a week.

You won’t really know until you fill out your 2013 tax return a year from now. But here are some of the ways your tax bill may change:

PAYROLL TAXES: The most immediate, and visible impact will be a relatively small increase (about two percent of your wages) that will come out of your first paycheck of the year. You’ll keep paying that “extra” tax until you’ve reached the wage limit subject to the tax, which this year rises to $113,700. (This tax shows up in the FICA line on your paycheck.) If you hit that limit before the end of the year, you stop paying the tax.

Though you’re paying more than last year, your payroll tax rate is now back to where it was in 2009, before Congress and the White House cut the tax to help boost the economy. That measure added about $20 a month to the average household’s spending power. Now, the government wants that money back to help close the deficit.

INCOME TAXES: Though taxes are going up a bit, all but the wealthiest households dodged the biggest fiscal cliff tax bullet: the expiration of the Bush-era tax cuts. Many economists feared that if those cuts were reversed all at once, the resulting dramatic tax increases would have siphoned off billions of dollars in consumer spending that would have sent the U.S. economy back into recession.

The new law left income tax rates alone, except for the new top bracket above $400,000 for individuals ($450,000 for couples) who will now pay 39.6 percent on every dollar over that amount, up from the current 35 percent. (They’ll pay the lower rates on money earned in lower brackets, just like everyone else.)

CREDITS AND DEDUCTIONS: Some upper-income households will also pay more because they’ll lose some of their tax breaks on itemized deductions for things like mortgage interest. Those will now be capped for individuals making more than $250,000 (couples more than $300,000.) They’ll also see their $3,800 personal exemption – the tax break everyone gets – phased out.

Parents will get to keep a $1,000 child tax credit that had been set to drop to $500. The new law also reversed a $600 cut in the $3,000 credit for child and dependent care that was due to take effect. Parents will continue to get the up-to-$2,500 tax credit for college tuition that was set to be cut.

CAPITAL GAINS, DIVIDENDS: Money you earn from capital gains or dividends on investments will still be taxed at 15 percent – unless your total income is more than $400,000 for individuals ($450,000 for couples. Those in the top bracket will now pay 20 percent – up from 15 percent.

Dividends and gains on investments held in a qualified account like a 401(k) will still be deferred until you withdraw the money when you retire. The new law also preserved increased limits for how much you can contribute tax-free.

ALTERNATIVE MINIMUM TAX: This stealth tax monster, which had threatened some 28 million unsuspecting households in 2013, has been permanently killed. Originally designed as a separate set of rules to close tax loopholes for “wealthy” families, the law’s architects forgot to take inflation into account, pushing more and more middle-income households into its path every year.

For years, Congress has “patched” the law at the last minute to save its new victims from an average $3,000 tax bump. The process also overstated how much the government collected because “official” estimates assumed it would be collected.

The new law makes that patch permanent. But that also means the budget now reflects the loss of those revenues, widening “official” deficit estimates.

DOCTOR FEES: Congress has also relied on a similar accounting gimmick with Medicare fees paid to doctors which are “cut” every year for bookkeeping purposes – and then “patched” at the last minute. The new law restores those cuts – which would have surgically removed 27 percent of your doctor’s Medicare income this year – but only for 2013. So you doctor still faces the prospect of a 27 percent cut in 2014.

UNEMPLOYMENT BENEFITS: Since the recession, Congress has added several “tiers” of extended unemployment insurance for jobless workers. The fiscal cliff would have eliminated extended benefits for those out of work the longest. The new law keeps them in place – but only for one year.

Low-income families also dodged cuts in the earned income tax credit that were set to take effect in 2013.

ESTATE TAXES: The fiscal cliff was also set to take a big bite out of money passed from one generation to the next. Last year, estates of up to $5,120,000 (per person) were exempt from federal tax, which then kicked in with a top rate of 35 percent for amounts over that. The fiscal cliff would have cut the tax-free limit to $1 million per person and raised the top rate to 55 percent.

The new law preserved the $5 million tax-free threshold and raised the top tax rate to 40 percent.

Though many of the deep ‘fiscal cliff’ spending cuts were postponed in the new law, Congress has yet to complete work on that side of the budget ledger, leaving a number of federal programs in play that could affect household budgets.

And while many of the just-enacted tax provisions are “permanent,” it remains to be seen how long they remain in force.