What Does the ‘Fiscal Cliff’ Mean for your Personal Tax Burden?

The “fiscal cliff” is a term that refers to a series of tax increases set to take effect at the start of 2013. What are some of these tax increases, and what impact would they have for you?

We’ve all been hearing about the “fiscal cliff” in the news lately. It’s a term that has been coined that refers to a series of tax increases set to take effect at the start of 2013.

But what exactly are those tax increases, and more importantly, what do they mean for you and your family?

The taxes set to increase and/or take effect include:

  • Expiration of the 2001 and 2003 tax cuts enacted under the Bush administration
  • A compromise on the estate tax
  • A “patch” in the Alternative Minimum Tax reducing its impact
  • Expiration of the temporary 2% payroll tax holiday
  • New taxes enacted under the Patient Protection and Affordable Care Act (a.k.a. ObamaCare)

On top of all of this, mandatory spending cuts are set to take effect under the sequester legislation, and in late February, the government is set to hit the debt ceiling. Collectively, this is what makes up the infamous “fiscal cliff.”

A recent report from the Tax Foundation illustrates what these tax increases are and what they might mean for you. The report contains a number of compelling facts and figures which help paint the whole picture.

This table from the report outlines the total tax increases set to take effect on January 1, 2013:

Tax Changes Taking Effect January 1, 2013
Tax ChangeTax Increase (2013 over 2012)
Expiration of the 2001-03 tax cuts (not including estate)$156 billion
Expiration of the payroll tax holiday$125 billion
Failure to patch the Alternative Minimum Tax$88 billion
Expiration of business expensing$48 billion
Expiration of other “tax extenders”$40 billion
New PPACA (Obamacare) taxes$36 billion
Expiration of the 2009 stimulus$11 billion
Estate tax increase$10 billion
Total, Tax Increases  $514 billion
Source: Tax Foundation; Congressional Budget Office; Joint Committee on Taxation; Office of Management & Budget.

And what about income taxes? Here are a few key points noted in the Tax Foundation’s report about how income taxes will increase next year:

  • The lowest income tax bracket of 10% would expire, reverting to 15%
  • The top four income tax brackets would see rate increases as follows:
    • The 25% bracket would rise to 28%
    • The 28% bracket would rise to 31%
    • The 33% bracket would rise to 36%
    • The top bracket would rise from 35% to 39.6%

The tax on long term dividends is also set to go from a maximum of 15% to 20%, plus a new 3.8% capital gains tax on high income individuals as part of ObamaCare would also be instituted.

If you collect a regular paycheck, then you undoubtedly are aware of Social Security withholdings. Here’s how the expiration of the payroll tax holiday would impact your take home pay:

Payroll Tax Holiday Impact on Payroll Taxes
Payroll Tax Component20102011 and 20122013 (unless changed)*
Employee Share   
     Social Security6.20%4.20%6.20%
     Subtotal, Employee7.65%5.65%7.65%
Employer Share   
     Social Security6.20%6.20%6.20%
     Subtotal, Employer7.65%7.65%7.65%
Total Payroll Tax15.30%13.30%15.30%
Source: Tax Foundation*Payroll taxes for high-income earners will be higher due to PPACA (Obamacare) tax.

An example in actual numbers: if you make $50,000 per year, an increase in withholdings from 4.2% to 6.2% represents $1,000 total. That may seem insignificant but it does add up over time.

If you are at or near retirement, the collective impact of these tax increases could be especially burdensome if you no longer have the regular income you once had from working and are instead relying on other income sources, such as investments (be sure to read Carol Schmidlin’s article on the subject, Critical Tax Issues That MUST Be Addressed In 2012).

Could any of this ultimately affect the federal workforce in some way? It’s a possibility. Legislation addressing aspects of the fiscal cliff has been proposed in the past which would have an impact on federal employees (see for instance Federal Employees’ Pay Freeze Could Be Extended to Cover Payroll Tax Cut). It’s doubtful if any such legislation were to be resurrected that it would be signed into law, especially considering the president is on record as wanting to thaw the pay freeze in 2013.

Will we go over the “fiscal cliff?” That depends on the actions of Congress; as the Tax Foundation itself noted, “anything can happen.” It’s unclear at this point what actions, if any, legislators will take to avoid some of these tax increases which many people fear would harm an already fragile economy.

About the Author

Ian Smith is one of the co-founders of FedSmith.com. He has over 20 years of combined experience in media and government services, having worked at two government contracting firms and an online news and web development company prior to his current role at FedSmith.