SEMA eNews Vol. 15, No. 48, November 29, 2012

The “Fiscal Cliff” Explained: Expiring Tax Provisions Require Immediate Congressional Action

At midnight on December 31, a major provision of the “Budget Control Act” (BCA) agreed to last summer by Congress and the President is set to go into effect. The BCA called for Congress to pass legislation lowering the U.S. deficit by $1.2 trillion over the next 10 years. Failing to do so would trigger automatic government spending cuts and tax increases known as the “fiscal cliff.” Among them are the end of temporary payroll tax cuts, which will result in a 2% tax increase for most workers. There will also be an end to several tax breaks for businesses and changes in the alternative minimum tax that could result in more people having to pay, and higher tax payments for those who do. Several of these existing tax breaks came from the Bush tax cuts of 2001, which were extended under President Obama until the end of 2012. Additionally, spending cuts will take place in more than 1,000 government programs, including cuts in the defense budget as well as social programs, such as Medicare.   

Absent an agreement, to follow is a summary of the major changes slated to take place January 1, 2013:

  • The end of 2011 and 2012 temporary payroll tax cuts, resulting in a 2% tax increase for workers.
  • Tax rates in the top four brackets will be increased: 39.6% (from 35%), 36% (from 33%), 31% (from 28%) and 28% (from 25%).
  • Capital gains will be taxed at a 20% rate (increased from 15% currently).
  • Dividends received by individuals will be treated as ordinary income and taxed at the top income tax rate, rather than at the long-term capital gains rate (15%).
  • Estate tax reverts to pre-2001 levels. The exemption level will be decreased from $5 million to around $1 million and the top tax rate will increase from 35% to 55%.
  • Additionally, Congress never renewed a number of tax credits that expired at the end of 2011 (for example: research and development tax credit, deduction of state and local sales taxes, alternative minimum tax adjustment) and others expire at the end of 2012 (for example: 50% bonus depreciation, Section 179 deduction returns to $25,000 from its current level of $139,000).  

Most experts agree that the significance of the cuts and tax increases would produce another recession, if not a depression. The President and Congressional leaders are negotiating to avoid the cliff. Many analysts believe that if a compromise is reached, it won’t likely occur until late December. If an agreement is not reached, a compromise could still be reached early in 2013 and made retroactive to January 1. However, at that point, the financial markets may have already downgraded the U.S. credit rating and raised interest rates. 

SEMA will continue to closely monitor and report on the negotiations. For more information, please contact Dan Sadowski at dans@sema.org.

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