The highest inflation rate in more than 40 years is doing more than eroding the purchasing power of your income and assets. It’s also increasing your taxes, automatically and quietly.
Thanks primarily to the late U.S. Senator Robert Dole (R-KS), many sections of the tax code are indexed for inflation. The exemption amounts, tax tables, retirement plan contribution limits, and a wide range of other tax items have been changed annually to reflect changes in the Consumer Price Index.
But not all parts of the tax code are indexed for inflation, and that causes automatic inflation-induced tax increases for many taxpayers.
Perhaps the most important un-indexed parts of the tax code are the income levels at which Social Security benefits are taxed. One income level hasn’t been changed since the 1980s and the other since the 1990s.
The result is that a tax that initially was targeted at the highest-income retirees now applies to more and more Social Security beneficiaries each year. Currently about 40% of Social Security beneficiaries pay income taxes on part of their benefits. In time, it is estimated that about 80% of Social Security beneficiaries will pay taxes on their benefits.
The Congressional Budget Office estimates that the share of total Social Security benefits taxed will increase by 10% this year and another 10% next year. Total income taxes paid on benefits will increase by 37% in 2022 from 2021. Those estimates were made when inflation was lower than it’s been the last few months.
The maximum loan amount that’s eligible for mortgage interest deductions also isn’t indexed for inflation. That one really should be indexed for housing price inflation, not general consumer inflation.
The $10,000 annual limit on deductions for state and local taxes and the amount of tax-free gain from the sale of a principal residence also aren’t indexed for inflation.
Perhaps the biggest oversight in inflation indexing is the $3,000 annual limit on deductions for capital losses. That limit hasn’t changed since 1978, so it’s now a fraction of its initial value after adjusting for inflation.
Because these provisions aren’t indexed for inflation, when inflation increases taxes increase for many taxpayers without Congress having to enact a tax increase.