101: Fiscal Cliff


With the seemingly interminable election cycle finally behind us, all eyes in the nation’s capital are now fixed upon the rapidly approaching fiscal cliff—the package of automatic tax increases and spending cuts that will hit the economy in January unless Congress can agree on a new deficit-reduction plan.

While most Washington watchers seem to think that the two parties will strike some sort of compromise that will stop us from going over the cliff—and sending the economy back into a recession—most also agree that certain taxes are likely to rise as soon as next year. And while that’s not the type of cheery holiday news small-business owners would like to hear, there are several things that we can do between now and the end of the year to help soften the blow of any lumps of coal that the taxman may deliver.

Let’s start by looking at end-of-year bonuses. While most companies conduct their employee reviews and announce any bonuses during November and December, many don’t actually pay those bonuses until January or February. If your company falls into that group, you might want to reconsider and pay those bonuses before the year is up.

Because whatever the outcome in Washington, it looks like the payroll tax holiday that we’ve enjoyed for the past few years could expire in January. If it does, then the payroll contribution that employees make to Social Security will rise form 4.2% to 6.2% of wages, meaning that paying bonuses this year instead of next will allow recipients—yourself included—to keep more of that bonus check for themselves. Put another way, it means that you can effectively give your workers a bigger after-tax bonus this year (as opposed to next) without paying them an additional dime.

In addition to payroll taxes going up, expectations seem to be growing that taxes on capital gains and dividends may increase as well. The capital gains rate could rise from 15% to 20% and the dividend rate from 15% to as much 43.4% depending on your tax bracket.

In addition to speaking with you financial advisor about how to mitigate any negative effects these changes could have on your investment portfolio, you should also consider strategies for minimizing their impact on your business.

If you are looking to dispose of any company assets at a profit and can do so before year end, you can lock in the current 15% capital gains rate.  And if you regularly pay yourself and other key officers with distributions that are treated as dividends for tax purposes, there may be some serious cost savings associated with paying those out before 2012 comes to a close.

Some companies with lots of cash on hand are even declaring special dividends this year in order to give owners a return on their capital at the currently advantageous rate. But before you go raiding the company coffers, make sure that you can afford to do so and that it makes sense for the long-term health of your business. And take some time to consult with your tax advisor to ascertain which strategies can help your firm steer clear of that fiscal cliff no matter what happens in Washington.

More By Gregg Schoenberg
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