What is the Fiscal Cliff? How does it affect you?

/ BY / Personal Finance

If you've turned on the news or looked at a newspaper lately, you've probably heard a lot of talk about the "fiscal cliff." And if you're like many people, you're probably asking yourself, "What is the fiscal cliff, and how does it affect me?"

Fiscal Cliff 101

The fiscal cliff is the informal name given to the expiration of current tax cuts on December 31, 2012. It also refers to a number of new spending cuts that are set to be introduced. Currently, President Obama and Congress are in negotiations to try and reach a deal to prevent the fiscal cliff from occurring.

If Congress does not reach a deal before the end of the year, the country will “fall over the fiscal cliff.” If this happens, you can expect to see a number of changes in regards to taxes, employment, and the overall state of the economy.

What will change

One of the biggest changes you’ll see if the fiscal cliff occurs is the expiration of Bush Era tax cuts. These tax cuts have been in place since 2001 and have lowered income taxes overall in a number of ways. These include:

  • A 10% tax bracket for low income earners
  • Increased ceiling for the 15% tax bracket
  • Higher child tax credit ($1000 instead of $500) as well as higher adoption and dependent care tax credits
  • Increased amount of an estate exempt from being taxed

Additional tax cuts set to expire include payroll tax cuts. Currently, this tax cut reduce a worker’s share of Social Security taxes by 2%.

How it affects you

The question on your mind by now is probably, “How does this affect me?” The most obvious result of the fiscal cliff are higher taxes and fewer tax cuts and exemptions you can claim on your taxes. If the fiscal cliff occurs, you can expect to see:

Higher Tax Brackets

Your tax bracket depends on your income and is the percentage of taxes you pay on the money you earn. The more you earn, the higher your tax rate. Current tax brackets are divided as follows:

  • 10 percent -- income from $0-8,700
  • 15 percent -- income from $8,7000-35,350
  • 25 percent -- income from $35,350-85,650
  • 28 percent -- income from $85,650-178m650
  • 33 percent -- income from $178,650-388,350
  • 35 percent -- income over $388,350

After the end of the year, the 10% bracket will disappear entirely and the remaining brackets will go up to 15%, 28%, 31%, 36%, and 39.6%

If the higher tax brackets go into place, 90% of Americans will see their taxes go up in 2013. Financial experts estimate that the average American family will see an average increase of $3,446.

Increased Social Security Tax

Currently, the Social Security payroll tax is 4.2%. If the fiscal cliff happens, this will jump to 6.2%. A person making $50,000 a year can expect to see an additional $80 a month deducted from their paychecks for Social Security.

Higher Unemployment

The Congressional Budget Office has estimated that 3.4 million people (and possibly more) will lose their jobs as a result of the fiscal cliff. This would push the unemployment rate to over 9%. This loss would come from a slowing economy, layoffs, and cuts in government spending and budgets.

What Now?

Congress and the White House are attempting to reach a deal before the end of the year that would prevent the fiscal cliff from occurring. Difficulty in reaching an agreement has come from the Democrats’ favor of increased taxes for the wealthy and the Republicans’ push for spending cuts.

Regardless of whether the fiscal cliff happens or not, Americans can expect to pay more taxes. The deal that Congress and the White House are currently working on would simply make the increases less severe.

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