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How Inflation Still Increases Your Taxes

Last update on: Jun 16 2020

Inflation hits most of us with one or more tax increases every year, and that will continue for the rest of our lives.

Years ago, Congress began inflation-indexing many parts of the tax code to eliminate some unfairness and stealth tax increases.

Inflation erodes the purchasing power of the dollar. A person can receive a higher nominal income but have the same purchasing power after adjusting for inflation. Yet for many years the tax tables, exemption amounts and other factors weren’t indexed for inflation. People paid higher shares of their incomes in federal income taxes as their purchasing power remained the same or even declined.

Now, each year the IRS announces inflation adjustments to a number of tax code items.

Not every tax code section is indexed for inflation, however, causing intentional annual stealth tax increases on many Americans, especially retirees.

Perhaps the most conspicuous of the un-indexed tax items are the income levels for taxing Social Security benefits.

Up to 50% of Social Security benefits are included in gross income when adjusted gross income (AGI) exceeds $25,000 for singles or $32,000 for married couples filing jointly. Those numbers haven’t changed since the 1980s. Up to 85% of Social Security benefits are included in gross income when AGI exceeds $34,000 for singles or $44,000 for married couples filing jointly. Those numbers haven’t changed since the 1990s.

Each year, more people pay income taxes on their Social Security benefits because the thresholds aren’t adjusted for inflation. Now, more than half of Social Security recipients pay income taxes on their benefits, though the provision initially was meant to target only well-off beneficiaries.

A number of homeowner tax benefits erode with inflation.

Mortgage interest is deductible only when the mortgage debt doesn’t exceed $1 million for debt incurred before the 2017 tax law or $750,000 for debt incurred after that tax law.

Neither amount is indexed for inflation, making fewer homeowners eligible to deduct mortgage interest each year.

The $10,000 limit on state and local tax deductions enacted in the 2017 law also isn’t indexed for inflation.

Further, inflation indexing isn’t applied to the amount of tax-free gain on the sale of a principal residence.

The limit has been fixed at $500,000 for a married couple and $250,000 for single taxpayers since 1997.

Most investment tax levels aren’t indexed. The most egregious is the $3,000 limit on net long-term capital losses that can be deducted against other income. That limit hasn’t changed since 1978.

Taxes are one of the largest expenses of retirees. For most, taxes are going to rise even when Congress doesn’t enact increases. The tax code contains a number of automatic tax increases triggered by inflation.

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