The Infamous Fiscal Cliff: Effects On Our Personal Finances

Posted in Investing & Stocks, Taxes on

fiscal-cliff-effects

What happens if our nation goes over the fiscal cliff?

Meredith Johnson, a CPA and CFP® who works at Burr Pilger Mayer, helped me answer that very question. She shared a tax example of how a family would be affected. In this case, the family would have an increased tax burden of $3,000! She also explained some of the strategies she finds useful when advising her clients. 

Side By Side Comparison

Here is a side by side comparison of 2012 taxes vs. 2013 if Congress doesn’t act. In this example, a married couple both work and have two kids (one is a sophomore in college). The family makes $100,000 per year, lives in California, and has a $350,000 mortgage on a $420,000 home. They have modest capital gains, interest, and dividends, and they contribute approximately $1,000 to charity each year. None of the family’s strategies change between years, only the tax law.

Fiscal Cliff Tax Comparison

As you can see, if the family goes over the cliff they will see an income tax increase of $1,128. Additionally, the 2% employee payroll tax cut will expire at the end of 2012. The FICA withheld from their paychecks would be $5,890 rather than $3,990 in 2012, an increase of $1,900. That is a total tax increase of $3,028. In other words, that is $3,028 this family will have to cut from their budget and/or forgo saving.

In a case like this, Meredith suggests preparing for the fiscal cliff by doing the following:

1. Retirement Account Contribution – This is sound financial advice in any tax climate. You might have noticed in our example the family didn’t contribute in either 2012 or 2013 to a qualified retirement account. One way to go about doing this is to make the maximum contribution to a Roth IRA this year (pay the lower tax now and assume tax rates will be higher when you retire) and contribute to a traditional retirement account next year (get the tax deduction now and assume tax rates or your bracket will be lower when you retire). I often encourage clients to divide contributions to different types of retirement accounts to hedge changing tax climates.

2.  Harvest Capital Gains – This is an effective strategy as long as it doesn’t push the family into the next tax bracket. The current capital gains rate will rise if we go over the fiscal cliff, therefore, realizing a gain now has a tax benefit.

3. Delay Paying Estimated State Taxes –  This year our example-couple falls into the alternative minimum tax commonly referred to as AMT. However, next year they will probably not fall into AMT and will receive a greater benefit from deducting their California state taxes from their federal return.

4. Contribute to a Health Savings Account – To utilize this contribution you need to have a qualifying high deductible insurance plan. That might be worth it, considering the benefits of an HSA as a tax planning and savings tool. According to Meredith, “contributions to HSAs are an above-the-line deduction for all taxpayers, and the distributions from these accounts are tax-free if used for qualified medical expenses.” Our example family would save $260 in taxes for each $1,000 they contribute!

5. American Opportunity Tax Credit – This credit expires at the end of 2012. Our family has a child in college so they could receive a credit up to $2,500 for that student. They might consider prepaying tuition for a quarter/semester that begins any time through March 31, 2013, or purchasing the textbooks and lab equipment for classes before the end of the year.

Additional Fiscal Cliff Tax Tips

Each of our tax situations vary and some helpful tips don’t apply to the example above. I asked Meredith if there were other strategies she was using with clients to help them best prepare for the fiscal cliff. Here is a summary of what she mentioned.

If you have the flexibility (for example, you are self-employed), accelerate income into 2012 and delay deductions until 2013. Think about bonusing yourself money now and wait to buy expensive business equipment until next year.

Making purposeful choices about which assets you give to charity could save you thousands if not more. For example, giving appreciated assets now will have a greater beneficial impact on your taxes than if you wait.

She also cautioned that for higher income earners, the Pease Amendment could reduce the benefit of itemized deductions if we go over the fiscal cliff. Additionally, higher income earners can look forward to paying a medicare surtax on their investment income.

Please remember that everyone’s tax situation is a little different. If you think some of the ideas in this post apply to you, be sure to reach out to a qualified tax professional so you can maximize your tax savings in order to SaveUp!

This post was written by SaveUp’s personal finance contributing writer, Catherine Hawley, CFP®.

Share this Article with Friends and Family!

Leave a Comment!

Tagged ,

Written by Catherine Hawley

Catherine is a CERTIFIED FINANCIAL PLANNER (TM) who offers accessible and objective financial advice to individuals and families. Her aim is to help clients gain clarity and confidence so they can pursue their definition of financial success. You can find more information about her independent practice at www.catherinehawley.com. She has worked at Rhodes & Fletcher, LLC as a Personal Benefits Specialist and at the firms of Bernstein Global Wealth Management and Barclayʼs Global Investors. Catherine has a bachelors degree in communication studies from the University of California, Los Angeles where she was a scholarship athlete and captain of the womenʼs tennis team.