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The Fiscal Cliff : What Is It?

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If you've been reading or listening to any news lately, you've probably heard people talking about the United States' financial situation and an upcoming "fiscal cliff."  What does that mean?

The phrase fiscal cliff is a new way of describing the effects of current laws that will result in tax hikes and spending cuts.  None of this is guaranteed to happen, but it will happen unless Congress make new laws to prevent it from happening.

Many believe that the use of the word cliff is too dramatic and would prefer that it be called a fiscal hill or a fiscal slope.  However, that wouldn't sound nearly as exciting and wouldn't really paint the picture of how many things could change in a small amount of time.  And, indeed, there are a lot of different things that contribute to this fiscal cliff.

Expiration of Tax Cuts

Many tax cuts are scheduled to expire on 31 December 2012.  If this happens, 2013 taxes will be significantly higher for nearly all taxpayers.  These cuts that are expiring, actually two laws that together are often referred to as the Bush tax cuts, accomplished the following: This is a list of expiring tax cuts, not tax cuts that are coming.

All of these changes were written so that they were not permanent and were to expire on 1 January 2011.  However, in late 2010, Congress voted to extend them until 31 December 2012.  Without further extension or modification, all these tax cuts and changes will be gone on 1 January 2013.

Sequestration

Sequestration is a fancy way of saying "lots of mandatory spending cuts." In August 2011, Congress passed the Budget Control Act of 2011 to avoid hitting the legally-defined debt ceiling.  In this Act, Congress raised the debt ceiling and prevented that one particular chaotic government financial disaster.  However, in the Budget Control Act of 2011, Congress also gave itself specific guidelines and deadlines for dealing with our country's debt and budget problems.  Under the terms of the agreement, automatic spending cuts will occur beginning 2 January 2013.  These spending cuts will take around a trillion dollars out of current programs.  Half will come from domestic programs, and half will come from the military.

Lowering of the Child Tax Credit

The current $1000 per child tax credit is scheduled to revert to $500 per child on 1 January 2013.  This will increase tax bills for many families, including mine.

Increased Social Security Payroll Taxes

Working Americans are currently paying Social Security payroll tax at the rate of 4.2% of earned, W-2 reported wages up to $110,100.  This is  lower than the regular 6.2% rate due to cuts passed by Congress for tax years 2011 and 2012.  Social Security payroll taxes are scheduled to return to their usual 6.2% rate on 1 January 2013.  Social Security payroll taxes are part of the Federal Insurance Contribution Act (FICA) deductions made into law in the 1960s.  Therefore Social Security payroll taxes are listed on Leave and Earnings Statements (LES) or other payroll statements at FICA -SS, FICA - Soc Sec or something similar.

If this change occurs, working Americans will be contributing 2% more to FICA in 2013 than they did in 2012.  The limit for paying Social Security taxes increases to $113, 700 for 2013, meaning that the total amount of Social Security payroll tax will jump by $2,425 for employees who earn in excess of that amount, for a total tax of  $7,049.40 for those highly-paid employees.

There's More

There are many other small aspects of the potential fiscal cliff, but they don't apply to most military families.  They include the expiration of federal extended unemployment benefits, a change to Medicaid program payments, and new taxes imposed to pay for new health care laws.  I encourage you to learn more about these if they apply to you, but I will focus here on the items that apply to most of my readers.

Next in this series:

Congress can, and has, made last-minute changes to tax laws.  It is a distinct possibility that Congress will act to change some of these provisions before they take effect.  However, my motto is Prepare For The Worst, Hope For The Best.  Knowledge is the key to preparation, so it is important to know what the worst case scenario could be.

I will spend this week talking about changes that will happen if Congress does not act to prevent these changes from occurring.  If you have specific questions, please ask them in the comments.  I'll try to address everyone's concerns, so question away!

Also in this series:

 The Fiscal Cliff:  Your Pay

The Fiscal Cliff:  Your Taxes, Part I

The Fiscal Cliff:  Your Taxes, Part II

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