What is Taxmageddon?

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What is Taxmageddon?

If you don't know, that means you aren't prepared for what is shaping up to be the most damaging attack on your household finances.

You see, if Congress doesn't make a move by the end of this year, tax cuts that were implemented during former President George W. Bush's time in office will expire, tax rates will increase for all brackets, a payroll-tax holiday on social security will end, and investors will pay more for capital gains and dividends.

The impending doom has been dubbed "Taxmageddon."

What's worse is the looming tax policy chaos will hit the economy at the same time $1.2 trillion in automatic spending cuts will go into effect – known as the "fiscal cliff."

In a warning earlier this week, the nonpartisan Congressional Budget Office (CBO) noted that both the spending cuts and tax increases, slated to become effective in Jan. 1, 2013, will drain some $607 billion from the ailing U.S. economy next year.

The changes could pummel the nation, at least for a period, back into a recession.

"You can call this a fiscal cliff…or Taxmageddon," said Sen. Orrin Hatch, R-UT, earlier this week. "Whatever you call it, it will be a disaster for the middle class. And for the small businesses that will be the engine of our economic recovery."

What is Taxmageddon?

The following changes make up Taxmageddon, and could go into effect at the start of 2013:

  • Every one of the existing income tax brackets will be ratcheted up, starting with the lowest 10% bracket, which will be hiked to 15%. The 25% bracket will jump to 28%; the 28% bracket will go to 31%; the 33% bracket will be replaced by a 36% bracket and the 35% bracket will soar to 39.6%.
  • The maximum tax rate on long-term capital gains and dividends is only 15% currently. Starting next year, the maximum rate on long-term gains is scheduled to increase to 20%, and the maximum rate on dividends will skyrocket to a whopping 39.6%.
  • Investors in the two lowest income brackets who currently pay 0% will have to shell out 10% on long-term gains and 15% and 28% on dividends.
  • Workers will lose a 2% cut on social security taxes. That means an average $1,000 tax increase come Jan. 1 for virtually all workers.
  • The $5.12 million unified estate and gift tax exemption is fated to revert to a measly $1 million. Also looming is a monstrous estate and gift tax rate of 55%, versus the current 35%.

Taxmageddon and Washington

U.S. taxpayers want answers on how the tax and spending cut expirations would shape America's fiscal resurgence as January approaches and Taxmageddon takes hold.

The daunting CBO report, "Economic Effects of Reducing the Fiscal Restraint That Is Scheduled to Occur in 2013," claims that Taxmageddon and the fiscal cliff will cause the U.S. economic growth to dip in the first half of 2013 at an annual rate of 1.3% before returning to 2.3% growth later in the year, although some fear it would be even worse.

"The idea of piling another recession on top of such a slow and incomplete recovery is quite horrifying from the standpoint of the well-being of average families in this country," William Galston, a senior fellow at the Brookings Institution in Washington, told The Wall Street Journal. "It would be unconscionable to permit that to happen if there were obvious policy alternatives."

Canceling those tax breaks and spending policies would shelter the recovery and boost growth to roughly 4.4% in 2013, according to the CBO.

But, if lawmakers fail to implement policies that would trim ballooning budget deficits by a similar amount in the future, the national debt is destined to continue its ascent, jeopardizing future economic growth.

The answers of what lies ahead will be decided, of course, in Washington.

Republicans are lobbying to extend the Bush tax cuts and rework spending cuts slated to hit the Pentagon and other federal agencies. The cuts were programmed in order to meet terms of a deal agreed on during the summer of 2011 in a face-off over the U.S. national debt limit. The debt limit was raised as the government grew heavy handed in its efforts to augment the waning economy.

President Obama, however, has threatened to veto any move to modify existing polices unless Republicans consent to let the Bush tax cuts expire for household earning over $250,000 a year.

The real outcome is bound to pivot on presidential election results.

The tax breaks will likely be extended if Republicans are victorious and win the Senate and the presidency. If the Democrats prevail, the costly tax changes could take place.

There are a lot of unknowns lurking, but the more you know about Taxmageddon, the better chance you have of financial survival.

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