2021 was a year of skyrocketing prices across the board, and, in November, it was announced that inflation had sharply risen by 6.8 percent in one year. This was the sharpest surge in inflation in four decades, and consumers saw any wage gains wiped out by this inflation. At the end of 2021, new car prices were up by eleven percent, and prices at fast food restaurants were up by 7.9 percent.
The sharp surge in prices was one for the record books.
At the present time, it is uncertain whether inflation will improve during 2022 or will grow worse. However, Americans can be sure that when inflation is high, the impact of inflation on taxes owed is likely to be uneven.
Kyle Pomerleau, a senior fellow at the American Enterprise Institute, spoke on the influence of inflation when it comes to income taxes: “Because of differences in inflation adjustments, some taxpayers will feel inflation’s impact more than others.”
Consider the influence of inflation on taxpayers in 1981, the last time inflation was as high as it currently stands. Although taxpayers’ income had risen along with rates of inflation, tax brackets remained the same. Ironically, people owed taxes on nominal increases in income; however, those gains weren’t real gains. Therefore, inflation indexing was established in order to combat this issue.
Congress acted, but only after great pressure from the American public. They indexed income tax brackets and made some other provisions for inflation that would hopefully alleviate some of the pressure on taxpayers. However, they did not complete indexing on all tax provisions, and, in the time since 1981, they have chosen to adjust some tax brackets for inflation while others remain the same.
Homeowners in particular are affected by two key provisions that have not been adjusted properly by Congress. The $750,000 cap on mortgage debt which is tax deductible nor has an exemption of up to $250,000 (for single filers) or $500,000 (for married, filing jointly couples) on the sale of a residence been adjusted for inflation.
With an inflation adjustment, the exemption for those selling a home would be $411,000 for single filers and $822,000 for married, filing jointly couples. If a taxpayer has a large taxable gain from the sale of a home, that taxpayer will pay higher taxes compared to a wage earner whose taxes have been adjusted annually for inflation.
Other notable areas in which Congress has not set up any type of provision for inflation include capital gains, net investment income, and the cap on state or local tax deductions.
Wage earners may see a slight bump in their take-home pay as a result of inflation. The inflation factor has been used to adjust federal tax withholding tables has risen about three percent due to inflation indexing over last year’s one percent inflation indexing. Of course, the bump won’t be very much – a single taxpayer making about $80,000 each year – with no dependents and a simply return – will probably see about five extra dollars in a bi-weekly paycheck.
Those who contribute to 401(k), IRA, or Roth IRA retirement plans will benefit from inflation adjustments that are higher than those for income tax brackets. The top tax deductible contribution to a 401(k) will be up by about five percent.
Inflation is also bound to benefit those receiving Social Security benefits as well. Social Security recipients are likely to see a 5.9 percent increase in benefits during 2022. This is the greatest increase to benefits since 1982. However, this could result in higher taxes for some recipients – those who receive $34,000 as single filers and $44,000 for joint-filing couples. Out of 64 million who are likely to receive Social Security benefits in 2022, only about 30 million of them will draw enough to need to pay taxes on the benefits.