There is not enough digital ink to fully explore all the problems with Washington's dysfunctional debate about the fiscal cliff. But websites (and journalists) need to be fed. So we're seeing an outpouring of stories about what might happen, what should happen, and what will happen if nothing happens. Going over Niagara Falls pales in terms of excitement and suspense.
Underneath all the positions and reactions coming from politicians, advocates, and subject-matter experts, it is a safe bet that their public posturing is more extreme than their private negotiating positions. You'd think people would be more reasonable and nuanced in private than their public positions would indicate. I hope that's the case and stand ready for some fiscal shock and awe should workable and bipartisan solutions emerge.
Until those puffs of white smoke are visible over the U.S. Capitol, people have little choice but to play financial defense. Concern that dividends will lose their preferred 15 percent tax treatment and be taxed as ordinary income has already compelled numerous companies to declare special dividends this year, when favorable tax rates are assured.
[Read: Avoiding the Obamacare Surtax.]
Charitable giving also appears to have surged late in the year in response to the possibility (and it's only that) that donators will lose some of their charitable tax deductions in 2013. The White House has proposed cutting the value of top-earner deductions to 28 percent from 35 percent on the dollar. Republicans have tossed out several sets of deduction caps to raise federal tax revenues without restoring the higher income tax rates that preceded the Bush tax cuts that are set to expire.
Curbing deductions is also a much more direct path to limiting tax breaks than actually reforming the tax code. Rather than doing ideological battle with lobbyists and special interest groups over many contentious reform proposals, just let all the special tax perks stay where they are but put limits on how much benefit taxpayers can derive from them.
Another reason the affluent are giving away more money this year is that the nation's estate and gift tax rules are unusually lenient. The current rules allow estates of up to $5.12 million to avoid all estate taxes, and that level can be effectively doubled for a couple. Large estates that do face taxes must pay a levy of 35 percent, which is low by estate-tax standards. Gift taxes have also been relaxed. Unless Congress takes action, the $5.12 million exclusion will fall to $1 million, effective January 1. And that 35-percent tax rate will jump to 55 percent.
[Read: 7 Must-Do Tips for Retirement Saving.]
While financial advisers to wealthy folks scurry around in the remaining weeks of the year, the options for mere mortals--you and I--are much less exciting. Still, there are several scheduled changes in government rules in 2013 that may cause you to alter spending and investment decisions before the end of 2012.
Taxpayers who itemize deductions can deduct medical expenses in 2012 after they've exceeded 7.5 percent of their adjusted gross incomes. In 2013, that threshold will rise to 10 percent (it will stay at 7.5 percent for those 65 and older a few more years).
Fiscal cliff or not, higher-income taxpayers will have to pay more Medicare taxes next year to help fund Obamacare. The higher tax--2.35 percent versus 1.45 percent--will be applied on wage earnings above $200,000 ($250,000 for couples). They also will have to fork over 3.8 percent of their investment income, again to help pay for health reform.
[Read: Top 10 Individual Tax Breaks.]
Roth IRAs are funded with post-tax dollars but later distributions, including investment gains, incur no income taxes. As opposed to regular 401(k) and IRAs, Roths also do not have annual required minimum distributions (RMDs). With higher tax rates on the horizon, setting up a Roth or converting a 401(k) or IRA to a Roth is worth a serious look. While converting a tax-sheltered retirement account to a Roth would trigger income taxes, it might be better to absorb this hit before tax rates rise.
Likewise, the prospect of higher taxes raises the effective value of sheltering income next year by taking full advantage of retirement accounts that are funded with pre-tax dollars. Putting more money aside for retirement is also a prudent reaction to what surely will be a long-term decline in government safety-net supports. Social Security benefits are not going away, but retirees need to prepare for shouldering more of their retirement income and healthcare expenses.
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