From the Wall Street Journal, the article, reshared below, is entitled: “High Inflation Creates Tax Winners and Losers. What Are You?”
Inflation is about to ripple through the tax code – and the hodgepodge of tax provisions in the country means some people will get hurt and others won’t.
Since inflation has been high for nearly 13 years, middle-income workers will benefit from automatic annual adjustments to tax provisions, such as the standard income tax deduction. Some other facilities are frozen in time, held to specific dollar amounts from decades ago. Those amenities tend to squeeze higher-income households.
For example, the standard deduction for married couples is likely to rise to $25,900 from $25,100, according to Wolters Kluwer NV, which provides tax services to accountants and others. As nominal wages and prices rise, that adjustment will protect more money from taxes and will block inflation — currently more than 5% at an unadjusted annual rate — to trigger a sharp tax hike.
However, some home sellers will be squeezed because married couples can exclude up to $500,000 in gains from capital gains taxes. That figure hasn’t changed since a 1997 law, while the average house price has more than doubled since then.
“It’s a bit of a patchwork,” said Mark Prater, a director of PwC LLP and a former Senate Republican tax adviser who helped write that 1997 law, back to review this on the issue of amount. But we never did. We just never did.”
Each year, the tax code requires the IRS to adjust dozens of inflation provisions based on changes in consumer prices. The agency will probably announce the figures for 2022 in the coming weeks.
The levels of standard deductions and tax brackets, which are most important to middle-income taxpayers, should increase by about 3.1%. According to Wolters Kluwer, that is about double the increase of the previous year.
The result should be larger paychecks in January, after the IRS and payroll calculators update payroll tax calculations. Even for wages that are stable from December to January, home wages are likely to rise slightly for many as less money is withheld for taxes, helping workers cope with rising prices.
“For many people in the short term, this will definitely look and feel like a tax cut,” said John Ricco, an economic analyst for the Penn Wharton Budget Model at the University of Pennsylvania. “For others, in real terms, they’ve gotten a lot poorer” because of what they’re buying.
People who encounter a tax provision that is not indexed for inflation, such as the $3,000 limit on tax-deductible capital losses over ordinary income, a $25,000 income tax exclusion on Social Security benefits, or that $500,000 limit on tax-exempt home sales — will be hurt more during a period of higher inflation, as those benefits diminish more quickly.
The projected increases in many of the tax-related provisions will be less than the 5.9% increase in Social Security benefits and comparable to the 2.9% increase in the maximum wage subject to Social Security taxes. That’s because they generally follow different rules. The tax law of 2017 has moved to a formula based on a typically smaller measure of consumer inflation than the Department of Labor’s general consumer price index. Increases for tax-advantaged pension schemes follow a different formula.
Beyond the parentheses and standard deductions — and beyond what Congress is doing this fall to change taxes more drastically — Wolters Kluwer also expects other features of the tax code to change. The annual limit for tax-free gifts could rise to $16,000 from $15,000, and the maximum for a flexible health care spending account could rise to $2,850 from $2,750.
The confusing state of affairs stems from deliberate decisions by Congress over the past 40 years. The biggest step came in 1981, when lawmakers linked the brackets to inflation as part of President Ronald Reagan’s tax cuts.
Before that, during the high inflation of the late 1970s, the brackets remained stuck unless Congress changed them with new laws. When incomes and prices rise but brackets remain fixed, more income is taxed at higher rates – a phenomenon known as bracket creep.
But Congress didn’t tie everything to inflation, leaving some features static. Those decisions were often intentional as legislation was written over the following decades, Mr. Prater said.
Setting a dollar cap and leaving it unchanged can act like a sneaky tax hike — for a long time when inflation is low and a shorter time when it’s high. Lawmakers can count on receiving projected revenue by setting a static number, even if they expect a future Congress to change that.
For example, a 2010 law included new taxes on investments and wages that take effect when income reaches $200,000 for individuals and $250,000 for married couples, matching levels then-President Barack Obama set during his campaign.
Now more people pay those taxes than they did then, but that expansion hasn’t sparked many calls for change, though the Democratic Party’s threshold for where tax hikes could begin rose to $400,000.
“If Congress doesn’t adjust something for inflation, they’re basically saying we want this provision to eventually apply to a very broad swath of taxpayers, but we’re willing to build that out over a number of years,” said Jim Young, an accounting professor at Northern Illinois University.
The same goes for the $3,000 cap on capital losses that can be deducted from ordinary income, a level that went into effect in 1978. If adjusted for inflation, that figure would be over $13,000 today.
“I’m not sure why they set it at $3,000,” said Mark Luscombe, chief analyst at Wolters Kluwer. “Maybe the $3,000 logic wouldn’t look so good right now.”
Congress continues to create similar challenges elsewhere in the tax system. In 2017, lawmakers created a $10,000 cap on state and local tax deductions and didn’t tie it to inflation. So as state and local taxes rise, more people will be affected by the limit.
The child discount is also not linked to inflation. Instead, Congress has increased it periodically — from $500 to $1,000 to $2,000 to $3,000 in leaps and bounds over the past 20 years.
reshared from the Wall Street Journal; M. De Jean, Director of Marketing, NIU College of Business
