We’re Going Off the Cliff – Now What?

When I explained the so-called “fiscal cliff” back in September, I was confident we’d avoid the plunge, saying, “I think the problem will be addressed, albeit only temporarily, by Congress extending the deadlines.”

While that’s still possible, I may have been overly optimistic. We’re now a week away from tax increases for nearly all Americans and a potentially devastating reduction in government spending. Combined, it’s enough to put our economy into recession.

I still don’t believe these dire circumstances will come to pass, at least not for very long. I’ll explain why later. But since the fiscal cliff is close, it’s time to take a look at what’s going to happen to you if nothing happens in Washington.

Take-home pay

While several key tax breaks expire on Dec. 31, the changes probably won’t impact the first paychecks of the new year. That’s because payroll processors are still waiting to hear from the Treasury regarding 2013 tax withholdings. Until they do, they’ll use 2012 tables. New tables reflecting higher rates could be issued any time, however.

But even if 2012 rate tables remain in place, there’s something else that might shrink your take-home: Social Security. For the last two years, we’ve only had 4.2 percent of our wages withheld, rather than the traditional 6.2 percent. Starting Jan. 1, that break expires and we’re back to 6.2 percent again, at least on earnings up to $113,700. So if you gross $50,000 annually, you’ll take home $1,000 less in 2013.

Taxes

While fiscal cliff-related tax hikes pertain primarily to money earned after Jan. 1, 2013, there’s one provision that could affect your 2012 return: the expiration of protection from the Alternative Minimum Tax. According to the IRS, without a fix, up to 100 million taxpayers may not be able to file until late March, delaying refunds. In addition, joint filers earning more than $45,000 and single filers earning more than $33,750 could be hit with higher taxes on 2012 income.

If the fiscal cliff remains unresolved, there’s a plethora of potential tax hikes ahead. I won’t rehash them all here, primarily because it’s likely that at least some compromise will ultimately be reached. But if you want to see the worst-case, check out Ask Stacy: Are We Heading Toward a Fiscal Cliff?

Unemployment

If Congress doesn’t act before year-end, the federal extension of unemployment benefits will expire. That means those who lost their jobs after July 1, 2012 will only be eligible to receive 26 weeks in state unemployment benefits, rather than up to 73. As a result, more than 2 million of the long-term unemployed could lose benefits next week.

Your investments

If you’ve got stocks in a retirement plan or elsewhere, the fiscal cliff could wreak havoc on your portfolio. The reason is simple: Companies make money when people buy things. When consumers pay more taxes, they have less to buy things with. Combine reduced consumer spending with slashed government spending and you have an environment where companies from department stores to defense contractors will be less profitable. When profits drop, stocks drop.

How worried should you be?

In a story just prior to the presidential election called Is the Election Already Decided? Gamblers Think So, we explained that gamblers – people who put their money where their mouths are – are often much more accurate than polls and pundits when it comes to predicting outcomes. That certainly proved true in this year’s election: While virtually every prognosticator and poll insisted the candidates were in a dead heat, betting websites had Obama 2 to 1 over Romney.

Another place the “smart money” resides: the stock market. Like betting sites, the stock market is a barometer of what’s ahead economically. What’s it suggesting now about the fiscal cliff? Because the market has been holding up well – it’s up nearly 13 percent this year – the implication is the fiscal cliff is likely to be resolved.

But keep an eye on the market, and the news. It’s unlikely the worst-case scenario will unfold, but it is likely the ultimate deal will affect you.