Don't Panic: Prepare for Fiscal Cliff

With roughly seven weeks left in 2012, it might not even be possible for Congress to come together and agree on some compromises to prevent the impending fiscal cliff, according to experts.

The Tax Reform Act of 1986 was years in the making, but this Congress has mere weeks to get its act together and do something about the current tax reform needed, according to a webcast hosted by the American Institute of CPAs.

The combination of the expiring Bush tax cuts, the loss of the payroll tax holiday, the reversion of the Alternative Minimum Tax threshold to 2000 levels and various other provisions Congress never got around to extending, is something Mel Schwarz, CPA, JD, partner with Grant Thornton, calls the Taxmageddon portion of the fiscal cliff. The part is a number of spending cuts throughout the government that will begin in the new year.

Federal Reserve Chairman Ben Bernanke coined the term “fiscal cliff” back in February when he tried to explain that these actions would be reducing the deficit too far, too fast and at the wrong time, according to Stan Collender, senior partner at Qorvis Communications

In order to prevent out economy from falling over the fiscal cliff on Jan. 1, 2013, this divided Congress will have to do something it hasn’t been able to do in the last four year: work together and make compromises.

This Congress has one of the lowest approval ratings. Just before the election, only 21% of Americans approved the job Congress is doing, which is actually up from the record-low 10% set in August. And this sitting Congress will have more to deal with by the end of the year than just partisanship.

In the last weeks of the year, Congress is looking at a lame duck session. Just after a general election, some lawmakers returning for the end of the year will not be in the next Congress, and thus other politicians will be less likely to want to cooperate with those members. These members also won’t be up for re-election again, and so they may feel free to make unpopular decisions.

The estimate on Wall Street and by the Congressional Budget Office is that the country’s gross domestic product will drop by 0.5% in 2013 if the U.S. goes over the fiscal cliff. That decrease would put America’s GDP into negative territory and, thus, the country would be in another recession

“You go over the cliff and the outcry will be substantial,” Collender said, adding the Dow will drop sharply and suddenly.

Individuals will see their paychecks shrink as taxes increase, which will cause them to put pressure on their representatives in Congress.

The Treasury, according to Schwarz, believes it has the power to delay withholding tax changes if it thinks Congress will be able to come to an agreement

“It’s a technique that is available, but is not necessarily used without some level of caution,” Schwarz said.

Delaying the withholding tax change should only be done if a deal by Congress is definite. Otherwise, taxpayers will be facing even greater tax increases later in the year, which would decrease paychecks even more.

Collender put forth that the government might not want to change the withholding tables, anyway, so that Congress feels the pressure. The government would be better served by letting Americans feel the changes where it hurts most: their paychecks. Only then will there be reason for them to push at their representatives to get their acts together.

There’s not much to be done until we know what will definitely be happening. It’s too risky to behave as if the tax increases are all going to happen and harvest gains early if Congress comes to an understanding, according to Schwarz. However, it’s also too risky to ignore the situation. Some preparation needs to be made, but taxpayers should delay any actions for as long as possible.

“Don’t panic,” Schwarz said. “Don’t panic — prepare.”