I wrote a few weeks ago about how I wasn't all that worried about an increase in the marginal tax rate on income over $250K, and that a lot of doctors shouldn't be worried either.  After weeks of negotiations, it looks like we're headed over the fiscal cliff (keep in mind this was written on Saturday, so it's possible a miracle has occurred in Washington prior to publication), which is a lot more worrying to me for many reasons.  Let me explain why.

1) Macroeconomic effects

Many economists worry that the rapid increase in taxes for essentially all Americans will dramatically decrease consumer spending and tank the economy, sending us back into recession or worse.  I'm not smart enough to know if this is actually true or not, but a bad economy tends to be bad for my income and bad for my investments.  A recession would also encourage the government to maintain interest rates at rock bottom levels, which is bad for me since my only debt is a mortgage that has already been refinanced at a ridiculously low rate.

2) No Doc Fix

This week I emailed the president, my two senators, and my representative to quit screwing around with the doc fix.  Most importantly, dramatically cutting Medicare payments by 27% will decrease access to care for many patients.  My parents already can barely find anyone in their town who takes Medicare.  That phenomenon is gradually spreading throughout the entire country.  It also makes it harder for me to find people to follow-up on patients after their ED visits.

The effect on my income is also significant. Something like 20% of my patients are on Medicare or Tricare.  27%*20%= 5.4%.  I'm about to have my pay cut by 5.4%.  That sucks.  Many people think Congress will get this fixed in the first quarter of 2013.  I guess that's better than not fixing it at all, but even so, it will have rather severe effects on cash flow in physician practices.

3) No Social Security Tax Break Extension

While I'm of the school of thought that it was dumb to cut funding for a program that most people like that already was in fiscal trouble, this change will have a significant effect on most physicians.  For 2013, you have to pay Social Security Tax (6.2% from you and 6.2% from your employer) on the first $113,700 of your income.  In 2012, that was 4.2% from you and 6.2% from your employer on the first $110,100.  If, like most docs, you make more than $113K, your SS Tax will go up by $2524, or a little over $200 a month.

4) Elimination Of The 10% Tax Bracket

Many doctors are worried about the rate in the top tax bracket increasing from 35% to 39.6%.  They don't stop to think about how the loss of the lowest bracket will affect them.  Right now, the first $17,400 of taxable income (post-deductions) is taxed at 10%.  Without changes, that money will be taxed at 15%.  That's another $870 in federal income tax for a married doc (using 2012 limits).

5) Increases In Other Tax Brackets

It isn't just the top tax bracket whose rate will increase.  The 25% bracket will increase to 28% (increases taxes by $2160 using 2012 married cut-offs), the 28% bracket will increase to 31% ($2243 increase), and the 33% bracket will increase to 36% ($5127 increase).  A doc in the top bracket (taxable income over $388K), that's another $9530 in taxes.

6) Increased Investment Taxes

I don't have much of a taxable investment account right now, so this won't affect me much.  If you have a taxable investment account, going over the fiscal cliff increases your long-term capital gains taxes from 15% to 20% and your qualified dividend taxes from 15% to your regular tax bracket, which could be as high as 39.6%. For many people, that could increase taxes by thousands per year.

7) Increased Progressivity of Tax Code

Not only will taxes go up (on everyone), but they will become more progressive, hurting a typical doctor much more than a more average earner.  It's hard to calculate the effects of this, as everyone will be a little different.  Your personal exemption used to be phased out before the Bush tax cuts.  That means the $3800 exemption you get for each dependent starts disappearing at a certain income.  It isn't entirely clear what income this would occur at, but in 2009 the phase-out started at $250,200 and was complete at $372,700 (married.)  That means for someone with a taxable income over $372,700 and 3 dependents, you'll owe another $6019 in federal taxes.  But wait, there's more.  Your deductions (you know, charitable giving, mortgage interest, property taxes, state taxes etc) also get reduced.  Before the Bush tax cuts, this phase-out meant your itemized deductions were reduced by 3% of the total of your income above a certain threshold up to 80% of your total deductions. In 2009, that threshold was $166,800.  So if your taxable income were $400K, and you had $50K in itemized deductions, you'd lose $6996 of them.  At the 39.6% marginal rate, that'll cost you another $2770.

8) Child Tax Credit Reduction

The child tax credit is being reduced from $1000 to $500 per child.  That's okay.  If your taxable income was over $130K you didn't get it anyway thanks to the phase-outs.

9) Marriage Penalty Is Back!

Prior to the Bush tax cuts, it was possible for a married couple with disparate incomes to pay a lot more in tax than a couple with similar incomes, even for a similar amount of income.  They would also pay more than if they hadn't ever gotten married at all.  The Bush tax cuts fixed this problem.  If they're rolled back, the problem returns and will affect many of us, particularly if only one spouse is a high earner.

Putting It All Together

How bad could this potentially be?  Let's take a high-earning physician ($400K taxable income) with a large Medicare practice (60%) and 3 dependents.  His income will be decreased by 16.2% ($64,800) and his taxes could go up by $21,713 or more.  All told, his after-tax income is reduced by $86,513, or about 22%.  Even a good saver is going to have a dramatic decrease in lifestyle with a hit like that.  Most of us will take less of a hit than this theoretical worst-case scenario, but I would guess that the majority will probably have at least a 10% decrease in after-tax income as we plunge over the fiscal cliff.

What do you think?  How will you cope with this drop in after-tax income?  Comment below!  (Keep comments civil and on-topic.)