At the Edge of the Cliff: What Could Happen This Week

December 31, 2012

Key points

• A possible solution to the "fiscal cliff" could include a patch to the Alternative Minimum Tax, an end to Bush-era tax cuts for those earning $400,000 and up, a 20% capital gains and dividend tax rate for earners over the $400,000 threshold, and a continuation of current estate tax rates and exemptions.
• Two tax changes will go into effect on January 1 regardless of any fiscal cliff deal: an increased employee contribution to payroll taxes and a new surtax on investment income for those earning over $200,000 (or $250,000 for couples) per year.
• Any raising of the debt ceiling will likely be delayed until after the next Congress is sworn in.
• A fiscal cliff agreement could be reached as late as January 2 or 3, and then be made retroactive to the beginning of the year.?

Over the weekend, Senate leaders continued to try to reach an agreement that could avert at least some of the consequences of the so-called "fiscal cliff." A possible Senate bill would likely focus only on a handful of items:

• Patching the Alternative Minimum Tax (AMT). This is perhaps the most critical element of any package. If the AMT isn't patched, about 30 million more people will pay higher taxes via the AMT in the spring?resulting in an average hit of about $4,000 per taxpayer, according to the Tax Policy Center.¹
• Avoiding tax increases on middle-class taxpayers. Senate leaders are reportedly considering allowing the Bush-era tax cuts to expire for taxpayers earning more than $400,000 (rather than President Obama's preferred threshold of $250,000).
• Increasing the tax rate on capital gains and dividends to 20% for filers above the $400,000 income threshold.
• Continuing the current estate tax regime, which has a top tax rate of 35% after an exemption of $5.12 million.
• Delaying the automatic spending cuts set to kick in on January 1.
• Extending long-term unemployment benefits that are set to expire December 31.

Whatever the specifics of the bill, it would need bipartisan consensus to speed it through the legislative process?otherwise, a single Senator could delay action for several days using various parliamentary tools.

If approved by the Senate, the bill then goes to the House of Representatives, where House Speaker John Boehner has said he will allow it to be voted on. The bill could pass the House with all or virtually all Democrats voting for it, and only a handful?as few as 30?Republicans supporting it.?

This appears to be the last plausible scenario for an agreement that averts most of the fiscal cliff on or close to January 1, 2013. If talks collapse on this kind of deal, the two chambers could try to pass a stand-alone bill that patches the AMT.?

Tax changes unrelated to fiscal cliff

The payroll tax cut, which dropped the employee share of Social Security taxes from 6.2% to 4.2% in 2011 and 2012, is set to expire on December 31. Employees should expect to see the higher rate applied to their first January paycheck.

In addition, new taxes on investment income kick in on January 1. Individuals with incomes over $200,000 and couples earning more than $250,000 will see a new 3.8% tax imposed on their unearned income. This provision is part of the health care reform law and is unrelated to the fiscal cliff negotiations.

Finally, any last-minute package related to the fiscal cliff will not include a debt ceiling increase. Treasury Secretary Timothy Geithner recently announced that the United States would hit the debt limit of $16.4 trillion on December 31, and that the Treasury Department would begin taking "extraordinary measures" to avoid default. Geithner indicated that such measures could delay default for approximately 6?8 weeks, giving the new Congress until mid-February to resolve the debt ceiling issue.

How much time is left for a fiscal cliff deal?

Time is critically short, but efforts to finalize an agreement could go past the first of the year. Some in Washington say the current Congress could pass a fiscal cliff bill as late as January 2 (or even the morning of January 3, prior to the swearing in of the new Congress at noon) and simply make it retroactive to the beginning of the year.

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1. http://www.taxpolicycenter.org/taxtopics/quick_amt.cfm

Source: http://www.schwab.com/public/schwab/resource_center/expert_insight/todays_market/washington/edge_of_the_fiscal_cliff.html

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