"While some tax cuts in recent years are only temporary, and are scheduled to be followed by increases down the line, indexing works year after year, and it's likely to be a part of the tax law for the foreseeable future regardless of whether Congress plans to tinker more with the tax rates themselves," Jones noted.
When there is inflation, indexing of brackets lowers tax bills by including more of people's incomes in lower brackets - in the 15-percent rather than the 25-percent bracket, for example.
The formula used in indexing showed a small amount of inflation this year, but it would have taken only a slight change to turn the result negative.
"I think it's safe to say that no one in Congress or the IRS ever seriously contemplated a deflationary adjustment, which would have the effect of raising taxes in a down economy," Jones said. "In a sense, we just dodged a bullet that would have posed a difficult question to the tax authorities."
The examples below show the modest tax savings generated by indexing:
- Because of inflation adjustments, a married couple filing jointly with total taxable income of $100,000 should pay $12.50 less in income taxes in 2010 than they will on the same income for 2009 (compared to a $312.50 savings between 2008 and 2009).
- A single filer with taxable income of $50,000 should owe $6.25 less next year due to the adjustments (again, compared to a $156.25 savings with significantly higher inflation between 2008 and 2009).
- For taxpayers with more than $373,650 in taxable income in both 2009 and 2010, the maximum savings from indexing the tax brackets for 2010 will be $51 for joint filers and $39.75 for single filers (as compared to a $1,213 and $913.25 difference, respectively between 2008 and 2009).
Inflation Adjustments
Since the late 1980s, the U.S. tax code has required that federal income tax brackets be adjusted for inflation annually, and inflation adjustments have been inserted into the Internal Revenue Code in recent years with increasing frequency.
For example, the Code now requires over 50 other inflation-driven computations to determine deduction, exemption and exclusion amounts in addition to the 40 separate computations needed to inflation-adjust the tax bracket tables each year.
Most adjustments are based on Consumer Price Index figures for September through August immediately prior to the adjusted year. However, some inflation-adjusted figures are computed earlier and some later. For example, in May the IRS released the Health Savings Account premium deduction limits for calendar year 2010: they are $3,050 for individuals with self-only coverage (up from $3,000 in 2009) and $6,150 for individuals with family coverage (up from $5,950 in 2009).
Amounts such as the 2010 vehicle depreciation limits, however, won't be available until 2010 (the $2,960 regular first-year amount for 2009 was not released until March 2009), while the standard business mileage rate (that is currently set at 55 cents for the rest of 2009) isn't expected to be computed for 2010 and released until late November 2009.
In 2009, the so-called Code Sec. 219(b)(5) deductible amount allowed for contributions to retirement savings accounts (typically, IRAs) was first made subject to an adjustment for inflation. But because the final amount must be rounded to the lowest multiple of $500, the limit for 2009 remained at $5,000. Once again, rounding will push a $5,224 initial amount back down to $5,000 for 2010.
CCH's projections for other indexed amounts are based on the relevant inflation data released September 16, 2009, by the U.S. Department of Labor.
The IRS usually releases official numbers by December each year. CCH tax bracket projections are provided for illustrative purposes only, and should not be used for income tax returns or other federal income tax related purposes until confirmed by the IRS later this year.
Some Items Not Indexed
Jones observed that some items in the Code are not indexed for inflation and stay the same, while others rise by dollar amounts already written into the tax law.
"The exemption amounts for the alternative minimum tax are not indexed, which means that each year Congress must either increase the amounts by statute or expose additional households to the AMT," Jones said.
For 2009, Congress set the AMT exemption amounts at $46,700 for single individuals and $70,950 for married couples filing jointly. No amounts have been set for 2010, but Obama administration tax proposals contemplate further increases.
Standard Deduction, Personal Exemption Hold Steady
The standard deduction and personal exemption amounts are also subject to indexing; however, because of "rounding down," all taxpayers except those filing as heads of households will see no change for 2010. Heads of households get a $50 increase only because the tax code calls for rounding down to the nearest $50 and that the indexing for that filing status just breaks another $50 ceiling. Any increase in the standard deduction, of course, can produce lower taxes by decreasing the taxpayer's taxable income.
Single taxpayers and married taxpayers filing separately will see their standard deduction for 2010 the same as for 2010: $5,700. So, too, joint filers will realize no increase from indexing, keeping their $11,400 standard deduction amount. Heads of households will see a modest $50 increase to $8,400 for 2010.
The additional standard deduction for those age 65 or older or who are blind will remain at $1,100 in 2010 for married individuals and surviving spouses, and $1,400 for single filers. The personal exemption amount also will stay put at $3,650 in 2010.
Taxpayers have had to lose a good portion of the value of personal exemptions and itemized deductions when their incomes rise above certain levels, which have also been adjusted for inflation. For 2010, these "phaseouts" are slated to disappear from the tax code, but they may come back in future years if administration proposals are adopted.
"The removal of limitations on itemized deductions and personal exemptions, rather than indexing of brackets, is what will provide major tax savings in 2010 for many well-off taxpayers," Jones observed.
For a complete look at how income ranges for each tax bracket are projected to shift next, see the CCH chart below.
"Kiddie" Deduction, Gift Tax Exemption
In general, inflation adjustments are rounded to the next-lower multiple of $50, so if the adjustment produces an increase of less than $50, no increase is made. The "kiddie" deduction, used on the returns of children claimed as dependents on their parents' returns, increased only five times in the years 2001 through 2009. It last rose for the 2009 tax year. For 2010 the deduction will remain at that $950 level.
The Code only allows the gift tax exemption to rise when the inflation adjustment would produce an increase of $1,000 or more. The last increase occurred in 2009, when it rose to $13,000. It remains there for 2010.
