Resolution is a term that gets thrown around pretty liberally at the beginning of the year. Millions of Americans entered 2013 making resolutions to change their lives in some fashion and use the turning of the calendar as the catalyst. Congress had another type of resolution in its sights when it set out to address the fiscal cliff.
The resolution provided by Congress will be sweeping; few citizens will escape some form of tax increase. This fact alone should give many people reason to add to or alter their New Year’s resolutions to include some changes on the financial planning front.
The biggest impact to most Americans from the fiscal cliff legislation will come from the expiration of the payroll tax holiday, with rates increasing to 6.2 percent from 4.2 percent. This increase will be especially painful to the many who didn’t realize that the rates had been lowered the last few years. This 2 percent increase, which may not sound like a lot, will add up for most working Americans. A household making $50,000 per year will now see its monthly take-home pay decrease by approximately $80, which equates to $1,000 per year.
Taxpayers should begin budgeting now for any decrease in annual income, but they also need to prioritize where to make spending cuts to compensate for it. The reduction in the payroll tax acted as a great opportunity to increase contributions to employer-sponsored retirement plans (401Ks, 403Bs, etc.), and those who took advantage of this timing can use the expiration of the holiday as an excuse to scale back contributions by the amount they increased a few years ago.
While this will allow these taxpayers to “break even” in regard to take-home pay now that the 2 percent increase is reinstated, it could have a longer-term negative impact on financial independence during retirement. If they can afford it, most people would be wise to keep their qualified plan contribution steady and make up for the 2 percent loss in income from other areas, such as discretionary spending.
Increases in marginal tax rates will affect only individuals making more than $400,000 and families making $450,000 or more. Individuals and families at these income levels will see their marginal rate increase from 35 percent to 39.6 percent. As if this were not hefty enough, these same taxpayers will see their rate on the realization of long-term capital gains increase from 15 percent to 20 percent.
For anyone concerned about these increases, it becomes imperative to do a couple of things sooner rather than later.
First, consult with an accountant to determine how changes in the tax laws will affect you.
Second, begin to identify investments in after-tax accounts that you may be able to sell at a loss during the year to counteract gains that may exist toward the end. Using losses to negate gains is the easiest way to avoid paying higher capital gains tax rates, and often times investors wait too long to realize losses.
Lastly, make sure that the maximum allowable contribution is being made to any employer-sponsored retirement plan. These contributions are made with pre-tax dollars, meaning that they do not count toward a worker’s taxable income.
Deductions under attack
Another facet of the fiscal cliff legislation that will work against high-income earners is that the tax benefits of certain deductions are being phased out as well, and at income levels lower than those that apply to the increase in marginal tax rates. Individuals making $250,000, or joint filers making more than $300,000, can lose up to 80 percent of their deductions for property taxes, state income taxes, charitable contributions and mortgage interest.
Unfortunately, even with the revenues created by the aforementioned tax increases, Congress is still left to battle over the fiscal cliff again in two months, along with a fresh debate on the debt ceiling. Where the revenue/tax debate has had a larger impact on personal bottom lines, the looming concerns should have a larger impact on the financial markets and how investors should position their portfolios in preparation for spending cuts and corporate tax increases.
Kevin Fusco is senior vice president of Fusco Financial Associates, Inc. of Towson. He can be reached at 410-296-5400, ext. 109, or firstname.lastname@example.org.