How does the fiscal cliff deal impact the middle class taxpayer?

As everyone now knows, Congress reached a last minute deal to avoid the so-called “fiscal cliff.” Although the debt ceiling has been raised momentarily, the now brutalized and traumatized long-term debt “can” keeps getting kicked down the road, setting up more fiscal drama for Congress in the coming months. In other words, the latest deals are far from a permanent solution, and taxpayers will continue to face uncertainty as politicians continue to debate the ongoing fiscal issues in the coming months and years.

As most people know, the fiscal cliff deal primarily impacts higher income taxpayers. For example, families earning $450,000 or more and individuals earning $400,000 or more annually will pay higher income tax rates. In addition, the personal exemption phase-out (PEP) and overall limit of itemized deductions are reinstated for families with incomes over $300,000 and individuals with incomes over $250,000.fiscal cliff deal impact

But what impact will the fiscal cliff deal have on middle income taxpayers? First, let’s be clear on how middle class taxpayers are defined. The 2008 census reported the medium income as $50,233. The Pew Research Center suggests that the middle income range is 75 percent to 150 percent of the median income. This would make the middle class income range $37,675 to $75,350. To many, this range seems small, so let’s assume that the middle class income ranges from $37,675 up to $100,000 of annual income.1

Interestingly, if Americans are asked what class they think they’re in, the majority will say the middle class. But if asked to choose between the upper, middle, working and lower class, only 45 percent say the middle class, according to the Pew Research General Social Survey. Roughly the same share chooses the working class. Few pick upper or lower classes. More striking, this pattern hasn’t changed since the 1970s. The United States is now a much richer country, more Americans attend and complete college, and more work in white-collar jobs since the 1970s.2 Yet, perhaps because of sluggish income growth over the past generation, the share of Americans that consider themselves middle class hasn’t budged.3

The biggest impact on middle class taxpayers will be the end of the social security payroll and self-employment tax “holiday” that expired on December 31, 2012. Workers’ share of the Social Security payroll tax, which had been temporarily cut from 6.2% to 4.2% for two years, is back to the higher 6.2% level for 2013 and beyond. The result is smaller paychecks for wage earners. A worker making $50,000 in 2013 will take home $38.46 less per two-week paycheck, or $1,000 per year.

However, there were a number of tax provisions that were extended or made permanent that benefit the middle class:

  • There is a permanent increase in the AMT exemption amount to $78,750 (up from $74,450 in 2011) for married individuals filing a joint return and to $50,600 for single taxpayers (up from $48,450 in 2011). The exemption amounts will be indexed for inflation in future years.
  • The American Opportunity Tax Credit, the enhanced Child Tax Credit, and the enhanced Earned Income Tax Credit are extended for five years.
  • The deduction for qualified tuition and related expenses has been restored.

The corollary of increased income tax rates on higher income taxpayers is that income and capital gains tax rates that were scheduled to increase in 2013 on the middle class will not take effect. Barring any additional congressional action, tax and capital gains rates in effect on the middle class in 2012 will remain the same in 2013. As discussed above, the biggest impact on middle class taxpayers will be the end of the social security payroll and self-employment tax “holiday” that increases the workers’ share of the Social Security payroll tax back to 6.2% level for 2013 and beyond.

However, there has been much discussion about tax reform and broadening the tax base. Until Congress resolves the long term fiscal debt issues, middle class tax rates and exclusions remain subject to change.

If you have questions about how this impacts your specific tax situation, please contact your financial advisor.

 

Hewins Financial Advisors, LLC d/b/a Wipfli Hewins Investment Advisors, LLC (“Hewins”) is an investment advisor registered with the U.S. Securities and Exchange Commission (SEC) under the Investment Advisers Act of 1940. Hewins is a proud affiliate of Wipfli LLP. Information pertaining to Hewins’ advisory operations, services and fees is set forth in Hewins’ current Form ADV Part 2A brochure, copies of which are available upon request at no cost or at www.adviserinfo.sec.gov. The views expressed by the author are the author’s alone and do not necessarily represent the views of Hewins or its affiliates. The information contained in any third-party resource cited herein is not owned or controlled by Hewins, and Hewins does not guarantee the accuracy or reliability of any information that may be found in such resources. Links to any third-party resource are provided as a courtesy for reference only and are not intended to be, and do not act as, an endorsement by Hewins of the third party or any of its content or use of its content. The standard information provided in this blog is for general purposes only and should not be construed as, or used as a substitute for, financial, investment or other professional advice. If you have questions regarding your financial situation, you should consult your financial planner, investment advisor, attorney or other professional.
Dean Stange
Dean Stange

J.D., CFP® | Principal, Senior Financial Advisor

Dean Stange, J.D., CFP®, is a Principal and Senior Financial Advisor with Wipfli Hewins Investment Advisors in Madison, WI. As an attorney, Dean has provided estate and succession planning advice to business owners for more than 20 years. He primarily focuses on the ways in which business ownership, tax and estate issues can impact long-term financial planning.

No Comments Yet

Comments are closed

How does the fiscal cliff deal impact the middle class taxpayer?

time to read: 3 min