7 Income tax breaks eroded by inflation

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Inflation drives higher bills everywhere, from our favorite grocery store to the car dealership. It may also reduce the value of some key tax deductions and exemptions.

A handful of seemingly simple federal tax breaks are not indexed to inflation, which means they are not automatically adjusted every year, if ever, to keep pace with inflation.

So these deductions and exemptions lose value – or become available to fewer people – over time.

The federal tax breaks that have been doomed to this fate are as follows.

Social Security Income Tax Exemption

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It comes as a shock to many new retirees that their Social Security benefits are taxable. But Uncle Sam is not completely cold: he does not tax 100% of retirement benefits.

Between 0% and 85% of a retiree’s social security benefits are subject to income tax. The exact rate depends on the retirees’ tax status and what the federal government calls their “combined income.”

For instance, a retired couple who file a joint tax return and have between $32,000 and $44,000 in combined income would have to pay taxes on up to 50% of their Social Security benefits. Couples with more than $44,000 would have to pay taxes on up to 85% of their benefits.

But these income thresholds are not adjusted for inflation. This is a big problem for millions of retirees. When Social Security benefits were first taxed in 1984, it was expected that 10% of recipients would have to pay taxes. However, because the thresholds were never indexed to inflation, we got to the point where about half of those who receive Social Security owe taxes on their benefits.

Mortgage interest deduction

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The mortgage interest deduction is no longer as valuable as it once was. To be eligible for this deduction, you must itemize your tax deductions when filing your return instead of claiming the standard deduction.

However, the Tax Cuts and Jobs Act 2017 nearly doubled the standard deduction, making it a much more attractive option than the breakdown for the majority of taxpayers.

For some taxpayers, it still makes sense to itemize. But these people might be surprised when they calculate their mortgage interest deduction.

The 2017 tax law limited the deduction to interest on up to $750,000 of mortgage debt – but did not index that limit to inflation – according to the accounting firm Grant Thorton.

The explosion in home values ​​over the past few years likely means that a greater percentage of people are taking out mortgages that exceed this limit, meaning some of their mortgage interest is no longer deductible.

If home values ​​continue to climb, more homeowners who retail will find themselves unable to cancel all of their mortgage interest.

Exemption from tax on net investment income

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The Health Care and Education Reconciliation Act of 2010 created a new tax known as the net tax on investment incomeor NIIT, which came into force in 2013. This is a 3.8% levy that applies to income such as:

  • Interest
  • Dividends
  • Capital gains
  • Rental and royalty income
  • Ineligible annuities

Many taxpayers are fully exempt from the NIIT, meaning none of their income is subject to it. Specifically, the tax applies to individuals whose adjusted adjusted gross income is greater than the following amounts:

  • Joint joint deposit: $250,000
  • Groom filing separately: $125,000
  • Single: $200,000
  • Head of household: $200,000
  • Eligible widow(ies) with dependent children: $250,000

But these income thresholds are not indexed to inflation. Thus, an increasing number of Americans will end up owing the NIIT, as inflation will lead to increased incomes in the years to come. In other words, a tax that seems to apply to the “rich” now could affect the “middle class” later.

Medicare Supplemental Tax Exemption

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Even if they didn’t realize it, 2013 was a bad year for taxpayers. Not only did the net investment income tax come into force, but a additional Medicare taxcreated by the Affordable Care Act of 2010, came into force.

Taxpayers owe this tax if their “salary, compensation, or self-employment income (and that of their spouse if they file a joint return) exceeds the threshold amount for the individual’s filing status,” the IRS says. .

The income thresholds are:

  • Joint joint deposit: $250,000
  • Separate deposit for the bride and groom: $125,000
  • Single: $200,000
  • Head of household: $200,000
  • Eligible widow(ies) with dependent children: $200,000

Although these amounts may seem relatively high, they are not indexed to inflation. This means that over time more people will also end up owing this tax.

Capital loss deduction

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When your stocks crash – and millions can be linked to this scenario in 2022 – a silver lining is that you can sell your desperate losers and claim a tax deduction for your net losses. This capital loss deduction allows you to offset other income on your return, which means you owe Uncle Sam less.

At the risk of sounding ungrateful – after all, any deduction is a good deduction – the capital loss deduction is rather modest.

Before 1976, it was worth up to $1,000. A federal law passed that year increased the maximum value to $2,000 in 1977 and to $3,000 beginning in 1978.

Since? Crickets.

Since the deduction is not indexed to inflation, its maximum value remains at $3,000. This means that it has become much less valuable over the years. Indeed, if it had been indexed in 1978, this tax deduction it would be worth it up to $14,000 today.

State and Local Tax Deduction (SALT)

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The Tax Cuts and Jobs Act 2017 capped the value of the national and local tax deduction (SALT): The deduction is generally limited to $10,000 per tax return (or $5,000 per return for married people who file separately) — and those limits are not indexed to inflation, according to accounting firm Grant Thornton.

High-income earners who live in high-tax states are most likely to be affected by inflation which erodes the value of this deduction, provided they itemize their tax deductions. (The SALT deduction is only available to people who itemize their tax deductions rather than claiming the standard deduction.)

Exclusion of capital gains on the sale of a house

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Current federal law allows those who sell their homes to exclude from their taxable income a substantial amount of profits (capital gains) they realize on the sale of a home: up to $250,000 for single filers and $500,000 for married couples filing jointly.

The capital gains exclusion is not an itemized deduction, so it is available to any taxpayer who otherwise qualifies for it. However, the exclusion limits are also not indexed to inflation, which means that this tax relief becomes less valuable as the bite of inflation increases.

How to offset the depreciation value of these deductions

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When inflation strips the value of key deductions, you can retaliate by increasing other deductions, which in some cases will more than make up for any value you’ve lost.

For example, if you are eligible to open a health savings account, you can save hundreds or even thousands of dollars in taxes just by contributing to your account.

Increasing contributions to some retirement savings plans can also reduce your tax bill. You might not even be aware of all the breaks that retirement savers get, as we explain in “Few Baby Boomers Know That Retirement Tax Credit Exists.”

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