The Fiscal Cliff and Your Paycheck

It seems that every day we hear more and more about the coming “fiscal cliff.” I see articles about it on the internet, I hear stores about it on the news, and I even hear co-workers talk about it at work. Who knows whether or not our political leaders in Washington will come to an agreement (or whether they even should, but that’s an entirely different subject). We’ve all probably heard bits and pieces of what exactly the so-called “fiscal cliff” is, which is mostly the expiration of the Bush-era tax cuts along with large cuts in government spending. But, what’s the bottom line impact on your paycheck if no agreement is reached and all the expiring tax breaks do in fact expire?

The answer is going to be different for everyone, since we’re all in different situations. But I decided to run the numbers for my family… It’s not pretty. Basically, if the scheduled tax rates, deductions, and credits expire as planned, I am going to see a roughly $200 a month reduction in my take-home pay. That’s not exactly spare change. It will take some serious changes in the monthly budget to absorb $200 less money each month.

So, what are these tax changes scheduled to take place?  I’m glad you asked. There are quite a few, but I’m only going to cover the ones that impact me. I’ll bet they impact you as well.

Tax Rates

If you’re married filing a joint tax return, the first $17,400 in taxable income is taxed at 10%. Income over $17,400 and up to $70,700 is taxed at 15%.

In 2013, the 10% tax rate is scheduled to disappear, meaning all taxable income up to $70,700 is taxed at 15%.

To make this a bit easier to understand, lets say that you have taxable income of $30,000. In 2012, this would equate to a tax of $3,630 ($17,400 x 10% plus $12,600 x 15%). Using 2013 rates, this would equate to a tax of $4,500 ($30,000 x 15%).

Payroll Tax

Social Security is funded through a payroll tax of 12.4% of an employee’s annual earnings (up to certain income limits). Half of this (6.2%) is paid by your employer and half is paid by you. (Note: if you’re self employed, then you’re stuck paying the full 12.4%, though you can claim a portion as a tax deduction) In 2011 and 2012, the percentage that is withheld from employees paychecks was reduced from 6.2% down to 4.2%. For someone making $50,000 a year, this represents $1,000.

Child Tax Credit

Those of us with children under age 17 know all about the child tax credit. Under the Bush tax cuts, this tax credit was increased to $1,000. And since this is a credit, it is much more valuable than a deduction. This $1,000 credit is a direct dollar for dollar decrease in your tax liability. In 2013, the child tax credit is scheduled to decrese from $1,000 to $500.

Marriage Penalty

The Bush tax cuts included a provision that removed the “marriage penalty”. Essentially, the standard deduction was increased for married couples to be 200% of the standard deduction for single filers. So, the standard deduction for someone filing single in 2012 was $5,950, and the standard deduction for a married couple filing a joint return was $11,900 (exactly twice the single standard deduction). In 2013, the standard deduction for a married couple filing a joing return drops back down to 167% of the standard deduction for single filers. So, in 2013 if the standard deduction for a single filer is $5,950, the standard deduction for a married couple filing a joint return would be $9,900.

Basically, a married couple’s standard deduction will be $2,000 lower, meaning that an extra $2,000 will be taxed.

The Bottom Line

I’m hopeful that our leaders in Washingon will reach an agreement within the next week or so and bring all this “fiscal cliff” talk to an end. I’m not so sure that it will actually happen, though. But I would encourage you to take a look at your most recent tax return and do a little math to see how you would be impacted by the scheduled tax changes. You might be surprised at just how much your tax bill is scheduled to increase.