8 Unexpected Ways Inflation Can Lead to Higher Taxes

Inflation was the big economic story of 2022. Soaring consumer prices have hurt families in many ways — some of which aren’t so obvious.

You are probably aware of the sharp increase in the cost of borrowing, house pricesRent, fuel prices and groceries. But here’s something else to consider: how inflation can lead to higher taxes.

Important parts of the federal tax code are not inflation-indexed. Result: If inflation increases a family’s nominal income, this could lead to higher tax burdens, while many taxpayers are already struggling with soaring consumer prices. That would be an inappropriate double whammy for many Americans. Consider eight examples:

  • Social security benefits are taxed once a retiree’s “combined income” exceeds certain thresholds set at $25,000 for single taxpayers and $32,000 for married couples. Benefits are adjusted for inflation each year, but these thresholds are not. Depending on your benefit level, more of your Social Security check could be lost in taxes.

  • High-income taxpayers often face the Medicare supplement. This surcharge applies not only to earned income, but also to investment gains. Net capital gains tax is an additional 3.8% tax levied on dividends, interest and capital gains. The Medicare surcharge applies if your modified gross income exceeds $200,000 for single taxpayers and $250,000 for couples. These thresholds are not indexed to inflation. If inflation increases your income, you may be above the threshold.

  • Inflation increases both interest income from inflation-linked government bonds and the value of capital these bonds. That is the good news. The downside: Unless you hold the bonds in a retirement account, those gains are taxed as ordinary income in the year they accrue. This means that high inflation means more taxable income for inflation-linked government bondholders, leading to higher taxes. This is true even though bondholders do not receive inflation-adjusted NPV until they sell or their bonds mature.

  • Home prices have skyrocketed over the past year, leaving homeowners exposed to unexpected capital gains taxes if they sell. In a recent articleI have described the exclusion of capital gains when selling a main residence. A single applicant can exclude up to $250,000 in capital gains from a home sale without paying taxes. A married couple can exclude $500,000. These amounts have not changed since 1997.

  • Unlike real estate prices, stocks most certainly do Not skyrocketed in 2022. However, if stocks prove to be the long-term inflation hedge they have been in the past, investors could pay capital gains taxes on large nominal gains — but modest post-inflation returns.

  • The child tax credit reduces the tax burden for families with children under 17, but inflation could make the tax credit less effective. The maximum loan is $2,000 per child from 2022 to 2025. Inflation reduces the purchasing power of every dollar, so higher inflation shrinks the real value of the loan.

  • pay tuition fees? The income thresholds qualify for both Americans opportunity Tax Credit and Lifetime To learn Loans are not adjusted for inflation, which means some families will find they can no longer use those loans simply because their employer has given them a pay raise on the cost of living. What if you qualify? Like the child tax credit, these education tax credits are now worth less when adjusted for inflation.

  • Many conditions Don’t index your income tax brackets for inflation. Of the 41 states that tax wages, 15 of them, plus Washington, DC, do not automatically adjust their tax brackets for inflation. This means that rising nominal wages could push taxpayers into higher brackets at the state level.

what can be done John Goodman and Laurence Kotlikoff, a professor at Boston University, recently suggested several measures to reduce the tax burden caused by inflation. For example, they recommended indexing the federal tax code entirely for inflation and doing the same for the threshold at which Social Security benefits are taxed. They also suggested removing them income tax for all over the Social Security full board age.

This column first appeared on Humble dollar. It has been republished with permission.
Richard Connor is a semi-retired aerospace engineer with an interest in finance and an associate of Humble Dollar. Follow Rick on Twitter @RConnor609 and check out his earlier article.

https://www.marketwatch.com/story/8-unexpected-ways-inflation-can-lead-to-higher-taxes-11657818850?rss=1&siteid=rss 8 Unexpected Ways Inflation Can Lead to Higher Taxes

Brian Lowry

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