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Will Income and Taxes Keep You From Going Over the Fiscal Cliff?

Will Income and Taxes Keep You From Going Over the Fiscal Cliff?

In early January of 2013, the much acclaimed fiscal cliff came into being – bringing with it some news that may actually have made some taxpayers happy in terms of net income and taxable earnings on investments.

Although there may be revisions in the future, today’s fiscal cliff may affect you in the following areas:

  • Taxes on Personal Income – While today’s fiscal cliff will not affect everyone, those who file their annual taxes as an individual and earn annual income of at least $400,000 will now be subject to an income tax rate of 39.5 percent. This represents the largest income tax rate in nearly 20 years. Those who earn annual income of $425,000 or more and file taxes as head of household, and those who earn at least $450,000 per year and file jointly, will also be subject to the 39.5 percent income tax rate. Those taxpayers who earn less than these amounts and file taxes accordingly will not be affected by this new income tax rate hike.
  • Dividend and Capital Gains Tax – For those who earn more than $400,000 per year, there will also be an increase in tax rates on income from investment dividends and capital gains. This rate jumps from 15 percent to 20 percent. Here again, though, those earning less than the $400,000 per year threshold will continue to pay 15 percent tax on these types of investment earnings.
  • Estate Tax – As many expected, the fiscal cliff deal also brought with it an increase in estate taxes. These rates went from 35 percent to 40 percent, with a $5 million exemption. As in the past, this threshold amount will be indexed for inflation in the future.
  • Alternative Minimum Tax (AMT) – Another expected tax increase was that of the alternative minimum tax, or AMT. Here, however, the amounts were not as high as anticipated. While original estimates were for the AMT exemption to rise for $50,600 for single individuals and $78,750 for those who are married, the agreed upon figures were actually $33,750 for taxpayers who file as single individuals and $45,000 for those taxpayers who file their taxes jointly.

In addition, even though the early 2013 fiscal cliff deal did not specifically address payroll taxes, these will rise from the most recent rate of 4.2 percent to 6.2 percent, starting this year. Given this newly raised rate, it is estimated that approximately 80 percent of U.S. households may be affected by a higher payroll tax. This, of course, will result in a slightly lesser amount of net take-home pay.

Additional Fiscal Cliff Issues That Could Have a Future Effect

While many tax and income related issues were agreed upon in the early hours of January 2013, some of the items that are still up for future discussion include the solvency of Social Security and Medicare.

In all likelihood, revisions to either or both of these programs could mean a reduction in future benefits. With this in mind, those who are approaching retirement will need to invest and plan for potential future health care expenses accordingly.

Maximizing Savings and Investments in the Post-Fiscal Cliff Environment

With the post-fiscal cliff tax and income guidelines now firmly in place, there are ways to help in maximizing savings and investments in order to capitalize on various financial opportunities. For example, those seeking additional income may want to consider investing in dividend paying stocks. This can benefit many investors not only due to the unchanged dividend income tax rate, but also in light of the historically low income that continues to be generated by most bonds and CDs.

For those who fear putting all of their investment “eggs in just one stock basket”, exchange traded funds (ETFs) may provide a viable alternative in that investors can obtain a more diversified group of stocks.

An additional benefit that these investments can offer is a lower expense ratio than mutual funds. Similar to individual stock shares, though, ETF can be purchased and sold throughout the regular trading day, allowing investors to take advantage of daily high or low points when seeking to buy or sell.

The Fiscal Cliff Going Forward

Now that Americans know what the present fiscal cliff looks like, what can we expect going forward? Looking ahead, some of the key issues will likely be potential spending cuts to various entitlement programs – and especially to those that were left untouched in the January fiscal cliff deliberations.

Another hot topic appears to be coming to terms with the corporate side of the U.S. tax code. Those who believe that the current way of taxing large corporations is unfair will likely have their say – especially given the argument that U.S. corporations have recently been paying the lowest average amount of taxes as a share of profits for roughly four decades. In any case, both Democrats and Republicans will need to eventually come to an agreement – while the taxpayers earning a living and investing for the future remain in the middle.