A new year brings new tax numbers.
For years Congress has had the Internal Revenue Service adjust tax brackets and other provisions for inflation. (Revisions for 2020 are in the accompanying tables, and now is a good time to review them.)
But it’s equally important to remember key tax numbers that aren’t changing for 2020—because Congress hasn’t indexed them for inflation. And while inflation has been low recently, it hasn’t gone away.
As a result, millions of Americans are paying more to Uncle Sam because there’s no indexing for a variety of tax provisions, including homeowner benefits, tax thresholds on Social Security and investment benchmarks among others. The 2017 tax overhaul added more to this list.
The lack of an inflation adjustment is often intentional, says Len Burman, a tax economist who is a professor at Syracuse University and co-founder of the Tax Policy Center.
“A provision with a fixed-dollar limit is a good way for policy makers to phase in a tax increase slowly,” he says.
Consider tax benefits for homeowners over the past three decades. Once, home buyers could deduct the interest on any amount of mortgage debt. In 1987, Congress limited this break to deductions on up to $1 million of debt used to buy up to two homes, unindexed for inflation. If this limit had been adjusted, it would have been more than $2 million by 2017’s tax overhaul.
Instead of adjusting the $1 million limit upward, the overhaul pared it to $750,000, again unindexed for inflation. Lawmakers also capped write-offs for state and local property and income or sales taxes, or SALT, at $10,000 per return, with no inflation adjustment. A popular exemption of up to $500,000 per married couple of profit on the sale of a house ($250,000 for single filers) enacted in 1997 also isn’t adjusted for inflation.
Over time, these benefits will erode further.
Social Security recipients are also affected by inflation’s pinch. The income thresholds for including Social Security payments in taxable income haven’t changed since they were enacted in the ‘80s and ‘90s.
For example, the income thresholds requiring filers to report 85% of payments on their tax return have been $44,000 for married couples and $34,000 for singles since 1994. Karen Smith, a retirement-policy specialist at the Urban Institute, estimates that with inflation adjustments, they would be about $77,000 for couples and $60,000 for singles in 2020.
In 2020, nearly 62 million adults will receive Social Security payments, and payments will be taxable for about 32 million of them. Ms. Smith estimates that about 24 million, or nearly 8 million fewer recipients, would have taxable benefits if the income thresholds had been adjusted for inflation.
“Congress did it intentionally, as they wanted current recipients to help more with funding,” she says. Congress also changed the tax code’s overall inflation adjustments in the 2017 overhaul, to slow them down.
For investors, the inflation picture is more complex. Many have called for adjusting the “cost basis” of investments so investors aren’t taxed on inflation. Cost basis is the starting point for measuring taxable profit or loss.
Here’s a simplified example. Say that an investor bought shares for $5,000 two decades ago and sold them this year for $15,000. The taxable profit is $10,000, but about $2,600 of that is from inflation. If the cost were adjusted to exclude inflation, the investor’s tax would go down, and—proponents say—it would more accurately reflect what happened.
But Mr. Burman, who worked at Ronald Reagan’s Treasury Department, offers cautions. Lower rates on capital gains are a rough way to counteract the effects of inflation, he says, so that long-term capital-gains rates should rise if the basis is indexed. He adds that indexing capital gains for inflation without also indexing interest expense—which is overstated by inflation—would invite tax shelters that take advantage of that asymmetry.
Still, inflation adjustments remain missing from other investment provisions. The thresholds for the 3.8% surtax on investment income have been fixed at $250,000 for most married couples and $200,000 for most singles since 2013, when the surtax took effect.
The granddaddy of unindexed provisions may be one for capital losses. Since 1978, the tax code has allowed investors to deduct only $3,000 of net long-term investment losses against ordinary income like wages. Adjusted for inflation, that deduction would be more than $12,000. There’s also a marriage penalty because the $3,000 limit applies to both single and married filers. To fix that, the threshold should arguably be $24,000 for married filers.
But don’t hold your breath. Congress seems in no hurry to make this change—or any of the others.
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