What You Need to Know About the Fiscal Cliff Deal

If you’re like most Americans, chances are you’ve been keeping a close eye on the latest “fiscal cliff” developments.

The Council on Foreign Relations, an independent, nonpartisan membership organization, defines the “fiscal cliff” as a bundle of tax increases and spending cuts that were due to take effect at the end of 2012 and beginning of 2013. They note that the goal of these taxes and spending cuts was to cut the federal deficit by $503 billion between fiscal years 2012 and 2013—but given the still-fragile state of the economy, some fear that such cuts could have lead to a double-dip recession and more unemployment in 2013.

Our government intervened by passing the American Taxpayer Relief Act of 2012 in the early hours of January 1, 2013. You can read all 157 pages of the bill at Business Insider, but chances are you—and most people—are primarily interested in how this act will affect you.

Scott Brewster, a certified financial planner in Brooklyn, New York, spoke with us and noted that while tax rates are changing for those making over $400,000, even Americans making far less will notice that their paychecks are a bit smaller in 2013.

“The biggest change an average person will see is a 2 percent increase for their Social Security withholding,” Brewster says. “So for someone making $50,000 that could be $1,000 less a year. Unfortunately, a lot of people are going to be shocked.”

Brewster also notes that if you’re under the age of 65, medical expenses can now only be counted as deductions if they exceed 10 percent of your adjusted gross income (AGI); before the bill was passed, they only had to exceed 7.5 percent of your AGI.

Ray Martin of CBS MoneyWatch offers four additional ways the new tax rates will affect Americans in 2013. 

Higher Payroll Taxes: A new tax rate of 39.5 percent (up from 35 percent) will affect:

  • Single filers with taxable income over $400,000
  • Married couples with taxable income over $450,000
  • Married couples filing separate returns with income over $225,000
  • Heads of household with income over $425,000.

Martin offers the example of how a married couple making $650,000 would pay an additional $9,200. Those who make less than the threshold, meanwhile, won’t see any income tax change.

Higher Tax Rates For Long-Term Capital Gains and Dividend Income: People whose incomes crossed the thresholds mentioned above will also see a new capital gains and dividend income tax—a bump up from 15 percent to 20 percent. As Martin notes, someone with $10,000 in capital gains and $10,000 in dividend income would pay an extra $1,000 come tax time.

Limits on Personal and Dependent Exemptions: Martin points out that the following people would lose some or all of their exemption deductions:

  • Singles with a $250,000-plus AGI
  • Couples filing jointly with a $300,000-plus AGI
  • Heads of households with a $275,000-plus AGI
  • Couples filing separately with a $150,000-plus AGI

Martin gives the example that couple with a $450,000-plus AGI and two dependent children may pay $6,200 more come tax time.

Limits on Itemized Deductions: If your AGI matches those above, you stand to lose up to 80 percent of your deductions for mortgage interest, property taxes, state income taxes and charitable deductions. So a $450,000-plus AGI couple with $40,000 in itemized deductions could pay $12,600 more in taxes, according to Martin.

If this all sounds like bad news, don’t despair. Brewster points out some benefits in the American Taxpayer Relief Act. For example, the bill allows more people to convert traditional 401(k)s into Roth 401(k)s. Roth 401(k)s behave similarly to Roth IRAs in that Americans now have the option of putting taxed contributions into a 401(k), which they can then withdraw tax-free later in life. If you’re planning a conversion to a Roth 401(k), Brewster suggests working with an accountant to make sure you understand any taxes that may be owed.

Brewster also points out that the bill expands the American Opportunity Tax Credit, which offers a 100 percent tax credit for the first $2,000 put toward college, and a 25 percent tax credit for the next $2,000.

To find out how the American Opportunity Tax Credit will affect you at tax time, we recommend consulting your tax or financial professional.

How will the American Taxpayer Relief Act affect your finances? What will you do differently in 2013 as a result?

External Link Image Label Links to non-Ally websites

We provide links to third-party websites for your convenience. Although we provide a link, Ally Financial is not responsible, nor can we guarantee their products, services, or information. We suggest you review their online policy and security practices to learn about this third party and how they handle consumer information.

Leave A Comment