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?
TTFN
