Friday, July 13, 2007


Beginning in the late 1970s many items relating to federal taxation have been “indexed” for inflation annually – such as the personal exemption, the standard deduction amounts, and the individual tax brackets. As new tax deductions and credits are created Congress has generally provided for annual indexing of either the amount allowed or the applicable “phase-out” ranges.

However there are still several numbers in the tax code that have remained unchanged over the years. There does not seem to be any rhyme or reason for why these numbers have not been indexed. Most noticeable of these are the exemption amounts in the calculation of taxable Social Security and Railroad Retirement benefits, the rental loss allowance and phase-out, the maximum capital loss deduction, and the dreaded Alternative Minimum Tax (AMT) exemption amounts.

What brought this topic to my attention was an item in a “tax quip” email from Tax Mama. The email referenced an article from the March-June 2003 issue of Enrolled Agent Doug Thorburn’s Wealth Creation Strategies newsletter on this very subject. His quarterly newsletters, archieved on his tax practice website, are indeed interesting reading.

Two sets of numbers figure in to the calculation of taxable Social Security and Railroad Retirement. The initial exemption amounts are $25,000 for single taxpayers and $32,000 for married couples. Plus up to 85% of benefits can be taxed as income in the calculation exceeds $34,000 for singles and $44,000 for couples. The initial exemption was instituted in 1984 when SS and RR benefits first became taxable, and the second set of numbers came into play in 1994 when the maximum taxable benefit was increased from 50% to 85%. Doug’s 2003 article reported that had these numbers been indexed for inflation since day one the adjusted numbers for tax year 2002 would have been $44,422 and $56,861 and $60,415 and $78,183.
The maximum rental loss deduction has been $25,000 and the phase-out $100,000-$150,000 since 1987, when the Tax Reform Act of 1986 created the current passive activity rules. According to Doug, indexing would have brought these numbers to $40,344 and $161,378-242,067 for tax year 2002.
Since 1978 the maximum capital loss deduction has been $3,000.00. If your have a net capital loss of $10,000 for the year the most you can deduct is $3,000.00. Of course, if you have $10,000 in net capital gains the full $10,000 is taxed. The inflation adjusted amount for tax year 2002 would have been $8.759.
I have had many clients who made $100,000-$200,000 in capital gains, many short-term, during the boom years of the late 1990s only to lose $100,000-$200,000 in the early 2000s when the bubble burst. They paid tons of federal and income taxes when they made the $100,000-$200,000, but were limited to a $3,000 annual deduction when they lost. Several of these clients will never be able to recover all of their losses at only $3,000 per year!
The inflation adjusted numbers discussed above are for tax year 2002. Imagine what they would be for 2007.
The main reason more and more upper middle class taxpayers are falling victim to the dreaded AMT each year is because the exemption amounts have not been indexed for inflation since revised by the Tax Reform Act of 1986. While Congress has slightly increased the AMT exemptions as a temporary fix over the past few years the increases do not reflect what would have been the true inflation adjusted amounts.
The point of Doug’s article is that the lack of indexing for many important numbers has resulted in annual “back-door” tax increases for many taxpayers.

FYI, in addition to being an Enrolled Agent Doug Thorburn is also a pioneering author and educator researching early-stage alcoholism and other drug addiction problems. His research explains each sign of alcoholism, or symptom of alcoholism or prescription drug addiction. His books are acclaimed not only for their powerful self help qualities, but also they contribute to a variety of education programs. His “Prevent Tragedy” website is dedicated to helping people understand why we need to identify alcohol and other drug addicts, how to do so and, most important, what can be done to prevent tragedy.

Please forgive the fact that I cannot seem to get spaces between some of the above paragraphs. Blogger can be a real PITA sometimes. I will try to fix it later.

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