Indexing of brackets lowers tax bills by including more of peoples' incomes in lower brackets - in the 15-percent rather than the 25-percent bracket, for example. "This also means that across-the-board inflation adjustments to the brackets provide more relief for those in the upper brackets, since they share in the reduction within each bracket, not just their own marginal tax bracket," Jones said.
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, inflation-adjusted figures for Health Savings Accounts (HSAs) have already been officially released for the first time this year because of an accelerated timetable required by the Tax Relief and Health Care Act of 2006. For calendar year 2007, taxpayers with high deductible health insurance plans may make deductions up to $2,850 for individuals with self-only coverage, and $5,650 for individuals with family coverage. For calendar year 2008, deductions may be claimed up to $2,900 for individuals with self-only coverage and $5,800 for individuals with family coverage.
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 (AMT) 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.
In 2006, the AMT exemption amounts were $42,500 for single individuals and $62,550 for married couples filing jointly. The higher amounts lapsed and are now set for 2007 and again for 2008 at just $33,750 for individuals and $45,000 for married couples filing jointly. Congress, however, is expected to enact another round of temporary relief.
Standard Deduction, Personal Exemption Also Rise
The standard deduction and personal exemption amounts are also subject to indexing and these are projected to increase for 2008. These increases can produce lower taxes by lowering the taxpayer's taxable income. Single taxpayers and married taxpayers filing separately could see a $100 increase over 2007 in their standard deduction, to $5,450, while the standard deduction for joint filers will increase by $200 to $10,900. Heads of households will see an increase in their standard deduction of $150, to $8,000.
The additional standard deduction for those age 65 or older or who are blind, will remain at $1,050 in 2008 for married individuals and surviving spouses, but will rise $50 to $1,350 for single filers. The personal exemption amount will go up in 2008 by $100 to $3,500. These inflation adjustments can add up over time. For example, since the 1988 tax year, the standard deduction for joint filers has more than doubled, from $5,000 to the anticipated $10,900 amount for 2008.
Taxpayers can, however, lose a good portion of the value of personal exemptions and itemized deductions when their incomes rise above certain levels. Those "phaseout" levels are also adjusted for inflation. For 2008, married couples filing jointly will begin to lose some of the value of any itemized deductions when their adjusted gross income exceeds $159,950. Likewise, they will begin to lose some of the value of their personal exemptions when their adjusted gross income exceeds $239,950. However, some relief from this "stealth tax" is kicking in.
For 2008, the reduction in personal exemptions and itemized deductions is scheduled to be only one-third of what it was in 2005. That's because both "phaseouts," first started under the Revenue Reconciliation Act of 1990, are themselves now being phased out - by one-third in 2006 and 2007, two-thirds in 2008 and 2009 and completely repealed for 2010. For a complete look at how income ranges for each tax bracket are projected to shift next, see the attached CCH chart.
"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" standard deduction, used on the returns of children who are claimed as dependents on their parents' returns increased in 2001, from $700 to $750, and jumped next to $800 for 2004. For 2006, it increased to $850 and stayed there for 2007. For 2008, it increases again, to $900, but it will apply to more "kiddies," with the unearned income of child dependents up through 18 years old (23 years old if full-time students) being taxed at their parents' rates.
The tax 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 at the beginning of 2006, when the exemption increased to its current $12,000. This year's inflation figures aren't enough to push it over the next threshold, so it will stay at $12,000 for 2008.
