Monday, November 17, 2014


I do believe that indexing of tax items for inflation began with the Economic Recovery Tax Act of 1981, the first major tax act of the Reagan Administration.  ERTA called for the indexing of personal exemptions and rate brackets, effective in 1985, based on changes in the Consumer Price Index (CPI) for years ending in September of the calendar year preceding the tax year.  The landmark Tax Reform Act of 1986 indexed the Standard Deduction for inflation beginning in 1989.

As subsequent tax acts continued the concept of reducing deductions and credits based on AGI that began with TRA 86 most of the phase-out thresholds were indexed for inflation.  The American Taxpayer Relief Act of 2012 finally permanently indexed the dreaded Alternative Minimum Tax (AMT) for inflation

Today many items on the 1040 are indexed for inflation – but not all. 

“Retirement Distributions: Finding the Sweet Spot” by Michael McGilligan in the Fall 2014 issue of NATP’s Taxpro Journal discusses the taxation of Social Security and Railroad Retirement benefits.  Michael provides background on this issue and tells us that when the taxation of up to 50% of these benefits was first enacted, effective with tax year 1984 –

“. . . it was estimated that only 10% of Social Security recipients would be affected by the tax.  By the time the law was first amended in 1993 {to make up to 85% of benefits taxable – rdf}, about 18% of beneficiaries were affected.”

This change apparently “did not increase the number of beneficiaries subject to the tax, but did increase the amount of taxes for over half of the 18%”.

Michael goes on to say –

The Congressional Budget Office estimated that by 2005, 39% of beneficiaries had a portion of their benefits subject to tax.”

What changed?

The answer lies in what didn’t change – the thresholds used to calculate the taxable portion were not indexed for inflation and remain at the levels in effect in 1984 and 1994, respectively.  Therefore, without indexing, we can expect the percentage of beneficiaries subject to tax to continue increasing.”

“Social Security: Calculation and History of Taxing Benefits” Noah P. Meyerson, published by the Congressional Research Service on August 4, 2014, provides the following update -

According to the Congressional Budget Office (CBO), 49% of Social Security beneficiaries (25.5 million people) will be affected by the income taxation of Social Security benefits this year.”

An article from the March-June 2003 issue of Enrolled Agent Doug Thorburn’s “Wealth Creation Strategies” newsletter suggested that had the threshold numbers ($25,000 for single taxpayers and $32,000 for married couples for the 50% level. and $34,000 and $44,000 for the 85% level) 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.    .
Another item that has not been indexed for inflation is the $3,000 maximum current capital gains deduction.  If capital losses exceed capital gains on Schedule D you are only allowed to deduct up to $3,000 against other income.  Net losses in excess of this $3,000 limit can be carried forward to apply against net gains in future years.

When I first started preparing 1040s back in 1972 the maximum capital loss deduction was $1,000.  In went to $3,000 in 1978.  According to Doug Thorburn, the inflation adjusted amount for tax year 2002 would have been $8.759.

The maximum amount of rental loss that can be currently deducted on Schedule E under the passive activity rules created by TRA 86 has been $25,000, and the phase-out range for this deduction $100,000-$150,000, since 1987.  According to Doug indexing would have brought these numbers to $40,344 and $161,378-242,067 for tax year 2002.

Doug’s index-inflation estimates are for 2002.  Imagine what they would have been for 2014!

One final example.  The maximum deduction for a business gift has been $25.00 per person for the 40+ years I have been preparing 1040s.  The $25.00 limit was actually set by Congress in 1962!  That was 52 years ago.  In 1962 the median annual family income was $6,000, a new house cost $15,000, a gallon of gas was 25 cents, and a 1st class postage stamp was 4 cents.

The result of the lack of indexing for many important numbers on the 1040 is annual “back-door” tax increases for many taxpayers.

If it is appropriate to index some tax items for inflation why shouldn’t ALL deductions, credits, thresholds, etc. be indexed for inflation?


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