Everywhere you look, you find someone talking about the impending doom of “taxmageddon” a.k.a. the fiscal cliff. You can gather by the name that no good is expected to come from the tax disaster that lurks on the horizon. Congressional negotiations are underway to prevent.

Before panicking, though, it’s important to understand the potential outcomes, what each means for you, and what you can do to prepare. I won’t go into detail of all of the tax changes here, but if you want to appease your curiosity, the Journal of Accountancy lists the specifics of every tax change associated with fiscal cliff. Explaining the context of how we arrived at this point is relatively easy (a political stalemate which some members of congress are attempting to use to advance personal agendas and place blame for fiscal missteps in exchange for the financial health of the country).

Figuring out what to do, however, is not so simple given all of the moving parts which are shown in the detailed list of tax changes. What follows below will be highlights of key information impacting most people. If you have additional questions specific to your situation, you should contact a CPA or tax attorney to help you optimize your tax strategy.

What to Expect: Four Possible Fiscal Cliff Resolutions

As of the time of this writing (I’ve always wanted to say that), there are four scenarios that are being tossed around as potential outcomes for addressing the fiscal cliff:

  • All tax cuts from the President Bush era extended for everyone – This scenario isn’t all that interesting – business as usual, same as last year. This scenario is also highly unlikely given the current $1.3 trillion deficit in the U.S. Supporters of this strategy, combined with cuts scheduled for education spending, are saying “I value my wallet more than leaving this country a better place for my posterity.” People are looking for ways to make ends meet today, and I can’t fault them for that.
  • President Bush era tax cuts extended for middle class only – Again, the list is long but the key tax cuts/provisions you may have some interest in that would be extended are:
  • Marriage penalty amnesty
  • Higher income tax rates for individuals with greater than $200K taxable income
  • Higher capital gain tax rates for individuals with greater than $200K taxable income • Qualified dividends being taxed as ordinary income for individuals with greater than $200K taxable income
  • Stalemate – This is probably the worst case and, as a result, the most interesting of the scenarios currently on the table as a legitimate “response” to the quickly approaching deadline for any compromises to be made on taxes going into effect for 2013. This scenario results in taxes increasing for everyone instead of high earners (see #2 above).
  • Some Other Compromise – It’s always possible that some agreement will be reached where only a subset of the President Bush era taxes will be extended to everyone or there could be changes in the proposed rates for the nation’s top tax bracket even if an increase cannot be avoided.

What Can You Do To Prepare for the Fiscal Cliff?

  • Not a whole lot – Some people are of the mindset that they will try to “pull forward” as many gains as possible by selling stock now and recognizing all capital gains before there any tax increases structure but for reasons I won’t detail here, that may not be the right answer. Similarly, you’ll find some people that will defer charitable contributions to take the deduction at a higher tax rate
  • Pray to whatever gods you pray to – Pray that congress strikes some sort of deal that will drive meaningful change for the country, laying the foundation for growth instead of catering to dated expectations of what each political party is “supposed” to do.

The fact is that your financial strategy (including tax planning) should be long-term focused, and waiting until we know which outcome we’re facing can provide you context that will help you make the best decision instead of guessing what’s going to happen with the tax requirements for 2012 and beyond.

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