Inflation and Taxes: The 2024 IRS Inflation Adjustments

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While inflation may be a natural part of a country's economic growth, there's no denying its adverse impact on our day-to-day lives. Just a year ago, inflation hit a four-decade high, and everyday essentials like gas and groceries skyrocketed in price, leaving many of us balking at our bills at the checkout counter. The declining purchasing power of the dollar forced us to rethink our spending habits and, in many cases, tighten our belts.

But hey, it's not all doom and gloom: Inflation has declined, and there are some silver linings to what happened last year, at least when it comes to your taxes. We’re talking about the inflation adjustments that the IRS announced for the tax year 2024, which is part of its annual exercise to ensure tax norms align with economic changes.

Understanding Inflation

Put simply, inflation refers to a rise in the prices of goods and services and the consequent decline in a currency’s purchasing power. This means that over time, as prices increase, the value of one unit of that currency diminishes. This decline in purchasing power impacts the general public’s cost of living - that is the money you need for food, shelter, healthcare, transportation, and so on.

If you are a salaried individual and you get a raise that matches the rate of inflation, considering the diminished purchasing power and the increased cost of living, you would see no real “gain,” as such, even with that increased salary because every dollar will have the power to buy fewer goods/services than before. Also, your new salary could push you up into a whole new tax category even as you are unable to realize any real benefits of earning more.

This upward movement is referred to as bracket creep, which is exactly what tax indexing - the adjustment of tax rates to keep pace with inflation - is meant to prevent.

What is bracket creep?

Bracket creep, also known as “fiscal drag,” refers to a situation where inflation causes a person to be pushed into a higher tax bracket - _despite the fact that there is no real increase in purchasing power - _as a result of an increase in their income (say their employer gives them a raise to ensure their salary keeps pace with inflation).

So, as the cost of living rises, people's wages or salaries may keep up with inflation to some extent, but their purchasing power remains relatively unchanged. However, due to the progressive nature of income tax systems, higher nominal incomes can lead to higher tax rates being applied to a larger portion of people’s earnings.

Consequently, individuals may find themselves paying a higher percentage of their income in taxes, even though their standard of living has not improved.

How is inflation measured?

Inflation is typically measured using a metric called the consumer price index (CPI). In essence, the CPI generally measures the average changes in the prices that consumers pay for a basket of goods and services over a certain period.

The collection of goods and services in this “market basket” comprises the products and services that urban households buy, such as groceries, housing expenses, fuel, clothing, healthcare, communication services, and transportation.

The CPI takes the average price fluctuations of this basket to illustrate the price trends in the economy.

When the index value rises, it signifies inflation, representing the erosion of the dollar's purchasing power over time.

The converse is also true: When the CPI index value decreases, it signifies a decline in consumer prices over time and a boost in the purchasing power of the dollar. This phenomenon is commonly referred to as deflation.

Various stakeholders use the CPI:

  • Businesses use it to project their expenses and inform their budgeting.
  • Investors rely on this data to assess returns and make informed investment choices.
  • The government applies this information to its economic decision-making.

The CPI is integrated into the federal tax system to counter the effects of inflation. This brings us to the annual inflation adjustments that the IRS announces year on year.

What Are Annual Inflation Adjustments?

Every year, the IRS modifies the standard deduction, tax bracket ranges, other deductions, and phaseouts to account for inflation. And given the type of inflation seen last year, it stands to reason that these 2024 adjustments, which will apply when you file your taxes in 2024, are substantial.

Let’s take a look at the major changes made for the tax year 2024!

Inflation Adjustments 2024

Standard deduction

What is a standard deduction?

A tax deduction is an amount you can subtract from your taxable income, thereby reducing your overall tax liability. You can choose one of two options:

The IRS sets the standard deduction amount annually. Your standard deduction could include an additional standard deduction if you are above a certain age or if you are blind.

Tax Deductions for 2024

Filing status 2024 Standard Deduction 2023 Standard Deduction
Single $14,600 $13,850
Married and filing jointly $29,200 $27,700
Married and filing ‘separately $14,600 $13,850
Heads of household (single adults with dependants such as childrens $21,900 $20,800

For the tax year 2023, if you are filing as a single individual, the standard deduction will be $13,850, which marks a $900 rise from 2022. For married couples filing jointly, the standard deduction for 2023 will increase by $1,800, reaching a total of $27,700.

Filing Status 2022 Standard Deduction 2023 Standard Deduction
Single $12,950 $13,850
Married and filing jointly $25,900 $27,700
Married and filing separately $12,950 $13,850
Heads of household (single adults with dependants such as children) $19,400 $20,800
Surviving spouses $25,900 $27,700

Additional standard deduction

For 2022

As mentioned earlier, individuals who are 65 years old or blind have the opportunity to claim an additional standard deduction when filing their taxes. In 2022, this additional amount was $1,400 ($1,750 for single filers and heads of households). And those over 65 and blind were eligible for twice the additional deduction, which would be $2,800 or $3,500 based on their filing status.

For 2023

For 2023, the additional deduction is $1,500 ($1,850 for single filers and heads of households), which would be $3,000 or $3,700 for people who are over 65 and blind based on their filing status.

Income tax brackets

Income tax brackets have been automatically adjusted for inflation (the “indexation” of income tax) since 1985. This measure was introduced against the backdrop of the inflation experienced in 1981. And the purpose of these adjustments is to protect people from experiencing bracket creep.

Do note, however, that the income tax rates, comprising seven brackets (10%, 12%, 22%, 24%, 32%, 35%, and 37%), remain unchanged from year to year (unless tax legislation is passed). However, the federal income tax brackets linked to these rates are adjusted yearly to accommodate the impact of inflation.

2024 Tax Rates:

  1. For 2024, here are the key tax rates based on income brackets for both singles and married couples filing jointly:
  2. The top rate of 37% applies to single individuals earning above $609,350 and married couples above $731,200.
  3. Other rates: 35% for incomes above $243,725 ($487,450 for married couples), 32% for incomes over $191,950 ($383,900 for married couples), 24% for incomes over $100,525 ($201,050 for married couples), 22% for incomes over $47,150 ($94,300 for married couples), and 12% for incomes over $11,600 ($23,200 for married couples).
  4. For 2024, the Alternative Minimum Tax (AMT) exemption is $85,700, phasing out at $609,350 for individuals ($133,300 for married couples, phasing out at $1,218,700). In 2023, it was $81,300, phasing out at $578,150 for individuals ($126,500 for married couples, phasing out at $1,156,300).
  5. The maximum Earned Income Tax Credit (EITC) for those with three or more qualifying children is $7,830 in 2024, up from $7,430 in 2023.

Other Changes:

  1. The monthly limit for qualified transportation fringe benefits and qualified parking is $315, up by $15 from 2023.
  2. Employee salary reduction for health flexible spending arrangements is $3,200, and the maximum carryover amount for plans allowing unused amounts is $640, up by $30 from 2023.
  3. Medical Savings Account deductible for self-only coverage ranges from $2,800 to $4,150, with a maximum out-of-pocket expense of $5,550. For family coverage, deductibles range from $5,550 to $8,350, with an out-of-pocket limit of $10,200.
  4. The foreign earned income exclusion is $126,500, increased from $120,000 in 2023.
  5. Estates of descendants who die in 2024 have a basic exclusion amount of $13,610,000, up from $12,920,000 in 2023.
  6. The annual gift exclusion rises to $18,000 from $17,000 in 2023.
  7. The maximum adoption credit for 2024 is $16,810, up from $15,950 in 2023.

Certain items unaffected by indexing:

  1. The personal exemption remains at 0 in 2024, continuing the provision from the Tax Cuts and Jobs Act.
  2. There's no limitation on itemized deductions, also due to the Tax Cuts and Jobs Act.
  3. The modified adjusted gross income used for the Lifetime Learning Credit's reduction isn't adjusted for inflation, staying at $80,000 ($160,000 for joint returns) from 2020.

Based on the inflation adjustments to these brackets for 2023, individuals whose income could not keep up with inflation in 2022 could end up having to pay lower rates in 2023 compared to 2022, effectively receiving a tax cut that helps offset their losses.

Here are the tax rates and corresponding tax brackets for 2023.

Tax Rate Single Filers Married Couples Filing Jointly Married Couples Filing Separately Heads of Household
10% $11,000 or less $22,000 or less $11,000 or less $15,700 or less
12% $11,001 to $44,725 $22,001 to $89,450 $11,001 to $44,725 $15,701 to $59,850
22% $44,726 to $95,375 $89,451 to $190,750 $44,726 to $95,375 $59,851 to $95,350
24% $95,376 to $182,100 $190,751 to $364,200 $95,376 to $182,100 $95,351 to $182,100
32% $182,101 to $231,250 $364,201 to $462,500 $182,101 to $231,250 $182,101 to $231,250
35% $231,251 to $578,125 $462,501 to $693,750 $231,251 to $346,875 $231,251 to $578,100
37% Above $578,125 Above $693,750 Above $346,875 Above $578,100

401(k) and IRA Contributions

401(k)s

The 401(k) is an employer-sponsored retirement savings plan. Tax indexing also applies to how much you can contribute to your 401(k)s.

The 401(k) contribution limits for 2023 increased to $22,500 from $20,500. The contribution for people aged 50 or older (called a catch-up contribution) is also up in 2023, i.e., from $6,500 in 2022 to $7,500.

This table summarizes the 2022 and 2023 401(k) contribution limits.

Age Contribution Limit 2022 Contribution Limit 2023
Under 50 $20,500 $22,500
Above 50 $6,500 $7,500

IRAs

IRAs, or individual retirement accounts, are a tax-advantaged savings vehicle that offers a way for you to save for your retirement.

For 2022, the contribution limit is $6,000. However, individuals above 50 years of age can contribute $1,000 (in addition to $6,000), so the limit is $7,000.

For 2023, the limit for individuals under 50 is $6,500, while for those above 50, it is $7,500.

This table summarizes the 2022 and 2023 IRA contribution limits.

Age Contribution Limit 2022 Contribution Limit 2023
Under 50 $6,000 $6,500
Above 50 $7,000 $7,500

Capital gains

Capital gains refer to the profits earned from selling a capital asset and are taxed based on the duration for which you held that asset. Capital gains earned on the sale of assets held for less than a year are subject to short-term capital gains tax; the applicable tax rate is the same as the ordinary income tax rate that applies to you. Assets held for more than a year are subject to long-term capital gains tax; depending on your capital gains, the three tax brackets are 0%, 15%, and 20%.

As per the 2023 inflation adjustments related to qualified stock dividends and long-term capital gains, a married couple will not owe any tax until their income, including those gains, surpasses $89,250, which has increased from $83,350 in 2022.

Beyond that threshold, the rate is 15%. If a couple's income exceeds $553,850 in 2023, up from $517,200 in 2022, the 20% tax rate will come into effect.

For individual filers, the 15% capital gains and dividends rate will be applicable to income above $44,625 in 2023, compared to $41,675 in 2022. However, single individuals will reach the top 20% rate when their income exceeds $492,300 in 2023, an increase from $459,750 in 2022.

Tax Rate Single Head of Household Married Filing Jointly and Surviving Spouse Married Filing Separately
0% Up to $44,625 Up to $59,750 Up to $89,250 Up to $44,625
15% $44,626 to $492,300 $59,751 to $523,050 $89,251 to $553,850 $44,626 to $276,900
20% Above $492,300 Above $523,050 Above $553,850 Above $276,900

Earned income tax credit

A tax credit is an amount that you can deduct from the taxes you owe. This is different from a tax deduction, which reduces your taxable income, i.e., the amount of income on which your tax is calculated. The earned income tax credit is a tax benefit aimed at supporting individuals with low to moderate incomes. It offers a substantial reduction in tax liability, provided that your earnings fall below a specific threshold.

Some of the requirements to qualify for this credit are as follows:

  • You must have earned income during the tax year for which you're applying for the benefit.
  • Your earned income and adjusted gross income (AGI) need to be below a certain threshold.
  • Your investment income should not exceed a certain limit.

The EITC qualifications are summarized here.

Children or Relatives Claimed Maximum AGI (Single, Head of Household, Widowed, or Married Filing Separately) Maximum AGI (Married Filing Jointly) EITC Limit
0 $17,640 $24,210 $600
1 $46,560 $53,120 $3,995
2 $52,918 $59,478 $6,604
3 $56,838 $63,698 $7,430

Investment income limit

In 2022, the maximum allowable level of investment income was capped at $10,300, and for the following year, in 2023, it has been raised to $11,000.

Social Security COLA

The Social Security COLA, or cost-of-living adjustment, is the adjustment in social security benefits to counter the effects of inflation. The Social Security Administration (SSA) determines whether there will be a cost-of-living adjustment (COLA) included in the benefits for the next year, and if so, the extent of that increase. Normally, cost-of-living adjustments (COLAs) match the percentage rise in the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) over a specific period.

For 2023, Social Security benefits are up by 8.7% as a response to elevated inflation (the highest COLA since 1981). It surpasses the 5.9% COLA in 2022, which was already considered quite high.

However, do note that the income limits for taxing Social Security benefits are not adjusted for inflation.

Key Takeaways

  • Inflation can have an adverse impact on people's daily expenses, with prices of goods and services rising rapidly and purchasing power declining.
  • Tax indexing, which adjusts tax rates for inflation, helps prevent bracket creep, where individuals are pushed into higher tax brackets due to increases in their income despite there being no increase in the purchasing power of the currency.
  • Inflation is typically measured using the consumer price index (CPI), reflecting changes in the prices of a basket of goods and services over a period.
  • The IRS annually adjusts tax figures, including standard deductions, tax brackets, and phaseouts, to account for inflation.
  • For 2023, standard deductions have increased compared to the previous year for all filing statuses, providing potential tax benefits for taxpayers.
  • The contribution limits for 401(k) and IRA accounts have increased for 2023, allowing individuals to save more for retirement with tax advantages.
  • Tax rates for long-term capital gains and qualified stock dividends have been adjusted based on income levels and filing status for 2023.
  • The earned income tax credit (EITC) provides tax benefits to low- to moderate-income individuals, and the investment income threshold for eligibility has increased for 2023.
  • Social Security benefits for 2023 have seen an 8.7% increase, the highest cost-of-living adjustment (COLA) since 1981, to counteract the effects of inflation. The income limits for taxing Social Security benefits, however, have not been adjusted for inflation.

For optimal tax savings, it's crucial to stay informed about these inflation adjustments and determine which ones apply to you so you can be prepared for the 2024 tax season.