As I was reading my google alerts tonight, news popped up about financial planning and a term I had never heard before suddenly had me baffled. There’s a “fiscal cliff” looming over the U.S. and it has many financial planners worried for the January 1st deadline. I contacted my good friend and financial guru, Nicole Middendorf and asked her advice. In true Nicole form, she immediately responded and we chatted about the specifics behind what exactly was going on.  I wanted to know how the tax increases and debt could affect my family.

Here’s my understanding of the “fiscal cliff” in the simplest terms possible:  Think of the U.S. as an olympic figure skater. After spraining her ankle, the skater took 3 months off to rest and recover. After the 3 months, her coach demanded she perfectly land a quadruple axel while holding an infant on rusty skates, at gunpoint. The chances of the ice skater landing the axel with the infant and her ankle intact are minimal and if she’s shot, she won’t be able to compete again. Really, it’s a lose-lose.

Someone needs to take the infant out of her arms and ease the skater back onto the ice. That’s the government’s job, specifically Bernanke. The looming expiration of the tax cuts will sincerely hurt our struggling economy. (Forgive the figure skating reference. I watched, “The Cutting Edge” tonight.) Read below for the specifics behind the tax increases and what you need to do to make sure you’re educated and aware of how to skate on the thin ice, should it happen…

 First and foremost, what is the “Fiscal Cliff?” 

“Fiscal cliff” is the popular shorthand term used to describe the conundrum that the U.S. government will face at the end of 2012. U.S. lawmakers have a choice: they can either let current policy go into effect at the beginning of 2013 – which features a number of tax increases and spending cuts that are expected to weigh heavily on growth and possibly drive the economy back into a recession – or cancel some or all of the scheduled tax increases and spending cuts, which would add to the deficit and increase the odds that the United States could face a crisis similar to that which is occurring in Europe.

We’ve all heard about what’s happening in Greece. With tremendous debt and the failing currency, Greece has faced cuts within it’s infrastructure that have affected not only their own government but has caused major shifts in the country’s welfare. With reported suicides and worse, it’s clear that what some European countries are facing could happen to the U.S.

Tell it to me straight…

NPR recently wrote an article featuring the entire discussion in 3, easy, to read graphics sourced from The Committee For A Responsible Federal Budget.  The problem is, our tax increases are going to be $380 billion, while spending cuts are set for $100 billion. (NPR’s breakdown is brilliant,  I highly recommend you check it out.)

What’s going on with the tax increases? The problem is Congress’ failure to act along with decreasing funds. The $380 billion in tax increases are because of three main things:

 

Bandit 1: {The Alternative Minimum Tax}

The alternative minimum tax  is simply an alternative set of rules for calculating your income tax. Since almost every individual has to pay some sort of tax, the alternative minimum tax, (or the AMT,) determines the minimum amount each individual must pay. It doesn’t apply if you already pay a regular tax amount. However, because Congress has failed to act in each yearly session, we could all now be required to pay this tax. Fairmark has a great guide on knowing what causes AMT liability. With the past 3 years of this recession, almost all of us could qualify for this additional tax. With the AMT setting to increase, many families will now be at risk unless the government chooses to address the issue.

 

Bandit 2: {The Bush Tax Cuts}

Since President Obama decided to renew the cuts, it’s helped many American families pay less in taxes. President Obama suggested that any family making less than $250,000 should continue to have the cuts, but Congress hasn’t acted. Investopedia gives a great summary on the tax cuts:

The tax cuts lowered federal income tax rates for everyone, decreased the marriage penalty, lowered capital gains taxes, lowered the tax rate on dividend income, increased the child tax credit from $500 to $1,000 per child, eliminated the phaseout on personal exemptions for higher-income taxpayers and eliminated the phaseout on itemized deductions and eliminated the estate tax.

Without Congress stepping in, it’s easy to see how each facet of these cuts could affect families and individuals. Credits and tax breaks could completely disappear.

Bandit 3: {The Payroll Tax}

The payroll tax is 6.2% of pure annoyance to most workers. This amount comes out of every individuals’ paycheck to pay for Social Security. While Social Security is an entirely other debate, the tax was cut to stimulate the economy, (much like the dwindling ARRA tax credits.) Going from 6.2% to 4.2%, helped most workers keep a bit more of their paycheck to flush cash into the economy. With the cut disappearing, Americans will all go back to paying the normal 6.2% rate. (Interestingly, the tax is capped at $106,000 in earnings.) As an example, an individual earning about $50,000 saved $1k because of this tax credit.

 

The Biggest Chunk: Hurting the Unemployed

Also expiring is the extension of unemployment benefits given out earlier last year might be what affects the Cliff the most. While some cite this as a step forward in the economy, those out of work because of no fault of their own are still being hit hard as the economy struggles to get back on its feet. Unemployment Insurance has gotten notoriously difficult to those out of work, often demanding they take jobs for less than 1/2 their original pay or with hours that aren’t suitable to daycare. Sadly, the funds are drying up and the landscape in 2012 is only slightly better than 2009. Recent surveys have cited the longer an individual is unemployed, the less likely they are to be hired.

Bottom Line

As you can read in the Committee Responsible Federal Budget’s Report, the fiscal cliff should be taken seriously. In fact, it’s already affecting national businesses and our own school system. Scholastic Books recently reported that because of the potential of the “fiscal cliff” schools were cutting their spending at almost $1.2 trillion dollars.

“Many school districts are concerned about potential automatic cuts to the federal budget,” CEO Richard Robinson said in a statement.

The “fiscal cliff” isn’t fear-mongering, or partisan antics, it’s a serious blow to the average American household and businesses’ checkbook. We are quickly reaching a point of no return as a county with our excessive borrowing and the interest we are paying on our loans.

 

What Should I Do?

Nicole Middendorf, CFDA stated that the most important thing you could do was to max out your retirement account, which we know  is sound advice in any market. (The more we put away, the less our worry about the future, right?) Middendorf also stated that this year was  a good year to take the leap in income, funding retirement accounts, savings and educating yourself about the ebbs and flows of the market.

“Each individual needs to have as much income as they can this year. One of the first steps I would take would be to look at any taxable investment accounts and consider selling stocks to take gains; you want to do this before the tax rate increases. If you are a business owner, don’t rush to write-off your expenses before the year is over. Save some for next year when the increases take place so you are sitting at an equal level. The best thing you can do is to speak with a financial planner about your strategy to fund your future. A plan will eliminate fears and frustrations.” 

I’m truly thankful to have Nicole in my back pocket and I highly suggest you reach out to her if you have more questions. While normally I’d ignore a financial article, lately I’ve become more aware of how taxation and the market effect everything in their path, including Ava, John, Danny and myself.

Editor’s Note

Nicole is a dear friend and my favorite person when it comes to financial questions, including “Why can’t I find someone rich and famous to fix everything?” She always has the best answers like, “you’re too smart for that.” This isn’t a sponsored post. Anyone can sound like a pro at anything by having incredibly intelligent and passionate people around them. Thanks, Nicole!