Even More Taxing Richard Connor | Jul 14, 2022
INFLATION HAS BEEN the big economic story of 2022. Steep increases in consumer prices have hurt families in many ways—some of which aren’t so obvious. You’re likely aware of the hefty increases in borrowing costs, home prices, rents, gas prices and groceries.
But here’s something else to consider: how inflation can lead to higher taxes. Important parts of the federal tax code aren’t indexed for inflation. Result: If inflation leads to nominal increases in a family’s income, it could lead to larger tax bills at a time when many taxpayers are already contending with steeply higher consumer prices. That would be an ill-timed double whammy for many Americans.
Consider eight examples:
Social Security benefits are taxed once a retiree’s “combined income” crosses certain thresholds, set at $25,000 for single taxpayers and $32,000 for married couples. Benefits are adjusted each year for inflation, but these thresholds aren’t. Depending on your benefit level, a larger chunk of your Social Security check could be lost to taxes.
High-income taxpayers often face the Medicare surtax. This surtax hits not only earned income, but also investment gains. The net investment income tax is an additional 3.8% tax levied on dividends, interest and capital gains. The Medicare surtax applies if your modified adjusted gross income exceeds $200,000 for single taxpayers and $250,000 for couples. These thresholds aren’t indexed for inflation. If inflation leads to an increase in your income, you might find yourself above the threshold level.
Inflation boosts both the interest income from inflation-indexed Treasury bonds and the principal value of these bonds. That’s the good news. The downside: These gains are taxed as ordinary income in the year they occur, unless you hold the bonds in a retirement account. That means high inflation will mean more taxable income for holders of inflation-indexed Treasurys, resulting in higher taxes. This is true even though bondholders don’t receive the inflation-adjusted principal value until they sell or their bonds mature.
Housing prices have soared over the past year, which might expose homeowners to unexpected capital gains taxes when they sell. In a recent article, I described the capital gains exclusion for the sale of a primary residence. A single filer can exclude up to $250,000 in capital gains on a home sale without paying taxes. A married couple can exclude $500,000. These amounts haven’t changed since 1997.
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