Inflation can affect your taxes in many ways, positively and negatively. Certain items with the IRS are indexed. This means that they increase or reduce based on inflation.
As we all know, inflation is generally seen as a price hike, and this has positive and negative outcomes on our taxes.
The rapid inflation we have seen in the last two years has many pros and cons, and this post will address them.
Pros
Earlier, we mentioned that certain items under the IRS are indexed. Some of the items increase with inflation and positively affect taxpayers. Here are some of the advantages of inflation on your tax.
- Increase income contribution limits for IRA accounts, including Roth and Traditional.
- Increase of contribution limit to retirement accounts
- Increase the amount of EE and high savings bond used for education.
- Lifetime estate and gift tax exemption increase more than usual.
- Increase in the income tax bracket.
The increased tax bracket is beneficial to individuals with capital gains as it increases the 0% long-term capital gain tax bracket to allow higher-income individuals to qualify. The standard tax brackets are 0%, 15% and 20%.
Cons
Before we look at the cons of inflation on our taxes, let’s brush through the Stealth 2017 Hike. The stealth 2017 hike is how the IRS changed the inflation calculation for tax matters. They went from CPIU to chained CPIU.
The implication is that inflation calculation results in a lower percentage than before 2017.
In other words, the tax rates and other tax benefits you used to enjoy from inflation will no longer be as much as they used to be before the stealth 2017 hike.
Now, on to the cons;
- Social Security Benefits
The social security benefits begin to be taxable at $25,000 for individuals and $32,000 for joint filing. These amounts don’t increase yearly with inflation. These figures are static, and the downside is that some people are getting paid out more social security benefits while more are being taxed on the benefits as their income increases.
There is a bill to change that and increase the cash threshold for individuals to $35,000 and $50,000 for joint filing. However, this bill will also increase the social security taxable income limits on employee wages.
- Home Sale Exclusion
Based on an increased interest rate, some individuals want to sell their primary residence to make the most out of it. The home sale exclusion is set at $250,000. If you are a qualified individual, you can exclude up to this amount from the sales of your primary resident.
Joint filers can, however, exclude up to $500,000 from the sales of their primary residence. The problem here is that this figure has remained the same since 1997, and it’s not looking like it will be updated anytime soon.
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