Rising inflation is mixed news for taxpayers.
Many tax breaks will be higher in 2023. Others stay stagnant, as they have for years. Here’s how inflation can affect your tax bill.
We’ll first discuss the good news for taxpayers.
Income tax brackets will be wider in 2023 because they are annually indexed to inflation. Other tax breaks will also soar. Among them: Standard deductions. IRA payin caps. Income limits on EE and I savings bonds used for education. Lifetime estate-and-gift-tax exemption. Income levels for figuring whether long-term capital gains are taxed at 0%, 15% or 20%. And more.
But taxpayers will really start to see the effects of a stealth 2017 tax hike…
Using the Chained CPI-U to adjust federal tax items for inflation. Before 2018, annual inflation adjustments for the tax brackets and other write-offs were based on the Consumer Price Index for All Urban Consumers (CPI-U). Economists argued that the CPI-U tends to overstate actual inflation because the formula doesn’t account for how people change their spending patterns as prices rise. The economists claimed that the Chained CPI-U is a better inflation measure. As a result, the 2017 tax law permanently changed the inflation indexing from the CPI-U to the Chained CPI-U.
Using the Chained CPI-U results in lower annual inflation adjustments… And, thus, smaller annual increases to tax breaks than the regular CPI-U. We forecast that the Chained CPI-U will rise about 8.2% for the 12-month period from Oct. 1, 2021, through Sept. 30, 2022, the fiscal year for indexing 2023 tax items. Compare this with our forecasted increase of 9% or so for the regular CPI-U for the same 12-month period. This makes a tax difference, with lasting effects.
Many tax breaks and income levels aren’t indexed to inflation each year.
Let’s look at two of them. First, the taxation of Social Security benefits. For decades, the income thresholds at which Social Security benefits start getting taxed have stayed static at $25,000 for individuals and $32,000 for joint filers. These amounts don’t go up with inflation, despite the fact that Social Security benefits have gone up and people are generally earning more money than they did in the past. As a result, more cumulative Social Security benefits will be taxed this year than in 2021. A House bill would hike the $25,000 and $32,000 thresholds to $35,000 and $50,000. However, it would also have the 6.2% Social Security tax for employees and employers kick in again for workers with wages over $400,000, so it’s a no-go with Republicans.
Second, the home-sale exclusion. Since 1997, individuals who own and use a home as their main residence for at least two of the five years before the sale can exclude from taxable income up to $250,000 of the gain ($500,000 for joint filers). These figures might seem high, but they’ve never been adjusted for the appreciation in residential real estate during the 25 years this popular tax break has been in effect.