Going over the cliff: What changes, what doesn't

  @CNNMoney December 26, 2012: 3:16 PM ET
boehner reid

Senate Majority Leader Harry Reid may need to do some heavy lifting to pass a fiscal cliff deal in the Senate, after House Speaker John Boehner's so-called Plan B did not garner enough support in the House.

NEW YORK (CNNMoney)

Yes, there still could be a fiscal cliff deal by the end of this year. But given how things unraveled in Washington last week, there's also a good chance the country could go over the cliff for a time.

The good news: It won't be the end of the world.

The bad news: Going over the cliff could create problems that no one should have to deal with, simply because Congress and the White House couldn't get the job done on time.

Practically speaking, however, there is likely to be a "grace period" of a couple of weeks during which Congress could pass a deal to ward off the bulk of scheduled tax increases and spending cuts. And there are ways both may be postponed temporarily while lawmakers work that out.

Your paycheck: If you'll be paid the first week in January, your company's payroll processor will probably be cutting your check during Christmas week.

Since the IRS hasn't told the payroll companies yet how much tax to withhold for 2013, payroll processors will continue to use 2012 withholding rates for the early January paychecks. In that sense, your paycheck in early January won't be much different than what it was in December.

But your paycheck still could be smaller, because the 2% payroll tax holiday is expiring. Starting in January, workers will once again have 6.2% of their wages up to $113,700 withheld to pay for Social Security, up from the 4.2% rate that's been in effect for the past two years.

Effectively that means someone making $50,000 might get about $83 less a month in their paychecks. Someone making twice that would see their pay reduced by roughly $167 a month.

If you're getting a bonus, you'll likely have more withheld there, too, said Michael O'Toole, senior director of government relations for the American Payroll Association. That's because there's one supplemental withholding rate that applies to bonuses. This year it's 25%, but it's set to rise to 28% on Jan. 1, unless Congress decides to change it.

For paychecks that will be cut during the second, third and fourth weeks of January, payroll processors will follow withholding guidance that the IRS has said it will issue by the end of this year.

If there is no fiscal cliff deal in sight and the IRS advises payroll processors to follow 2013 law, paychecks processed in January will have more withheld than they do currently do.

There has been some debate, however, whether Treasury Secretary Tim Geithner has the authority to instruct employers to continue using 2012 withholding tables until further notice. If he does step in, the income tax withheld from paychecks processed in January would not go up.

Such a strategy runs the risk, however, that many wage earners, if not all, could end up being underwithheld for the year. That would be the case if Congress doesn't end up doing anything to avert the cliff in 2013 or lets the Bush-era rates go up on income above a certain threshold.

Your 401(k) and IRA: There's no telling how markets will respond if fiscal cliff gridlock persists into 2013.

They've been relatively sanguine so far. But that may not be the case going forward.

After news that House Speaker John Boehner tabled Plan B because it lacked sufficient support, U.S. stocks fell Friday by just under 1%. World markets also ended the day modestly in the red.

Then again, some believe, markets may not move much on fiscal cliff news - whether Congress cuts a deal soon or not.

Your 2012 tax return: Here's where things potentially become a dumb mess. The IRS warned lawmakers that if they don't act to protect the middle class from having to pay the Alternative Minimum Tax for tax year 2012 by Dec. 31, up to 100 million taxpayers may not be able to file their 2012 taxes until late March.

That would mean their refunds will be delayed. And they wouldn't be injecting those refunds into the economy during the first quarter.

Based on Treasury Department records from the past three years, refunds paid during January, February and March combined have ranged from $117 billion to $136 billion.

Related: What's in the fiscal cliff?

Government spending: Unless lawmakers avert the so-called sequester, a series of automatic cuts will reduce the budgets of most federal agencies and programs by 8% to 10%.

But that doesn't necessarily mean those cuts would have to occur immediately, according to a former official with the Office of Management and Budget.

Both the White House budget office and federal agencies themselves will have some latitude to postpone the cuts from occurring "for several weeks if necessary," added OMB Watch, a group that monitors the federal budget.

The White House Budget Office did not respond to questions from CNNMoney.

What the heck is the sequester?

U.S. economy: Economists expect the U.S. economy would fall into a recession if Congress does nothing to avert the fiscal cliff and lets it stay in effect.

Specifically, the CBO forecasts a drop of 0.5% in real gross domestic product and a 9.1% unemployment rate by the end of next year.

On the bright side, no one expects that Congress would let all fiscal cliff measures have their way with the economy for an extended period.

But there could still be an economic hit if lawmakers push the country over the fiscal cliff temporarily and then pass a fallback deal that primarily just averts some of the tax increases.

For example, Congress may end up waiting a few weeks and then pass only a stopgap measure that does not address the scheduled automatic spending cuts or raise the country's debt ceiling.

In that case, economic growth could be dragged down somewhat in the first half of next year, according to economists at Goldman Sachs.

And that would come on top of a drag on growth that Goldman Sachs already expects from three things it believes are likely to happen: the expiration of the payroll tax cut, the expiration of the Bush-era tax cuts on the highest income households, and the start of the new Medicare surtax on high income earners.

Doctors' pay: Absent a fiscal cliff deal that includes a so-called "doc fix," Medicare physicians are facing a nearly 27% cut in their payments for treating Medicare patients.

But here again there may be a few weeks' grace period for Congress to change its mind and reverse the cut. That's because a claim submitted will be paid no less than two weeks after it's received.

Unemployment benefits: A federal extension of unemployment benefits is set to expire. If Congress does not renew it, workers who lost their jobs after July 1, 2012, will only receive up to 26 weeks in state unemployment benefits, down from as many as 73 weeks in state and federal benefits that have been available in 2012. As a result, more than 2 million of the long-term unemployed will run out of benefits in January, according to the National Employment Law Project, an advocacy group.

If Congress chooses early next year to keep the extension in place, and makes the extension retroactive, then many of the 2 million who fell off the rolls may be paid retroactively, said Rick McHugh, a NELP staff attorney. To top of page



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