Taxpayers who are still recovering from the economic downturn will get at least some relief in 2013 by way of the mandatory upward inflation adjustments called for under the tax code, according to CCH.
CCH released estimated income ranges Friday for each 2013 tax bracket and also offered projections for the growing number of other inflation-sensitive tax figures, such as the personal exemption and the standard deduction.
“Indexing for inflation has become an established part of our tax system, and it’s likely to be a part of the tax law for the foreseeable future, even as Congress debates changes to the tax rates themselves,” said CCH senior federal tax analyst George Jones in a statement.
Projections this year, however, are clouded by the uncertainty of expiring provisions in the tax code. If Congress allows the so-called Bush-era tax cuts to expire at the end of 2012, many taxpayers could lose more ground than they will otherwise gain. These tax cuts, first enacted within Economic Growth Tax Recovery and Reconciliation Act of 2001 (EGTRRA) with a 10-year life, were last extended by the 2010 Tax Relief Act, but only for two years through 2012.
When there is inflation, indexing of brackets lowers tax bills by including more of taxpayers’ incomes in lower brackets—in the existing 15-percent rather than the existing 25-percent bracket, for example. The formula used in indexing showed an average amount of inflation this year of about 2.5 percent—the highest in several years. Most 2013 figures therefore have moved higher.
For 2013, however, the big question—as it was in 2010—is not whether the brackets will continue to increase because of inflation—they will. Rather, it is what tax rates will be applied against those brackets.
The current 10, 15, 25, 33 and 35-percent rates are now officially scheduled to sunset to the pre-EGTRRA rate structure of 15, 28, 31, 36 and 39.6-percent. While no one in Washington is calling for a full sunset of all the current tax rates, congressional gridlock might produce a cliffhanger on what will happen until after the November elections, and perhaps not even before January when the new, 113th Congress convenes. In the meantime, there are three possible alternative scenarios being debated by lawmakers:
• Extend the current tax bracket structure in its entirety;
• As proposed by President Obama, keep the current rate structure except revive the 36 and 39.6-percent rates, starting at a higher-income bracket level of $200,000 for single filers, $250,000 for joint filers, $225,000 for head-of-households and $125,000 for married taxpayers filing separately, also indexed for inflation since initially proposed in 2009 but keyed to adjusted gross income (AGI) rather than taxable income (indexed 2013 projections for those AGI levels, based on the Administration’s FY 2013 Budget, are $213,200 / $266,500 / $239,850 / and $133,250, respectively); or
• As proposed by certain Senate Democrats, raise the top tax rate only for individuals making more than $1million.
In other words, it gets complicated quickly without knowing yet which approach Congress will take.
The examples below show the modest savings generated by indexing of the 2013 individual income tax rate brackets for taxpayers in three typical situations. In the third situation—a taxpayer in the highest rate bracket—tax outcomes are computed both with and without sunset of the current upper bracket rates.
Add to those savings the additional tax savings realized by slightly higher standard deduction and personal exemption amounts for 2013 in most cases, as well amounts that might be claimed from an increase in the income ceilings imposed on tax benefits such as education credits, individual retirement account contributions and more. Combined, inflation-based tax savings for 2013 can become substantial.
• Because of inflation adjustments, a married couple filing jointly with a total taxable income of $100,000 should pay $202.50 less income taxes in 2013 than they will on the same income for 2012 because of indexing of their tax bracket for 2013.
• A single filer with taxable income of $50,000 should owe $101.25 less next year due to the adjustments to the income tax rate brackets between 2012 and 2013.
• For taxpayers with taxable income over the start of the top 35-percent bracket, the maximum dollar savings from indexing the tax brackets for 2013 will be more dramatic, but only if the upper brackets do not revert to pre-2001 rates of 36 percent and 39.6 percent, or President Obama’s rate structure for higher-income taxpayers is adopted.
o If all 2012 tax rates are extended, not only is the top 35-percent rate bracket projected to rise from $388,350 to $398,350, but as is the case for all individual taxpayers, the rise in the bracket amounts below the individual’s top marginal rate (that is, the incremental value of the 10, 15, 25, 28, and 33-percent brackets for someone in the 35-percent marginal rate bracket) also benefits the individual taxpayer. As a result of the inflation adjustment in each of the brackets someone filing a joint return with taxable income of $450,000 in 2013, for example, will pay $793.50 less in income taxes in 2013 than in 2012 simply because of the built-in inflation adjustments.
o If President Obama’s plan is adopted, joint filers with $450,000 in taxable income instead would pay approximately $5,653.40 more in federal taxes in 2013 than they will in 2012.
o If all 2012 tax rates are allowed to sunset, joint filers with $450,000 in taxable income instead would pay approximately $14,600 more in federal taxes in 2013 than they will in 2012.
Since the late 1980s, the U.S. tax code has required that federal income tax brackets be adjusted for inflation annually, and inflation adjustments have been inserted into the Internal Revenue Code in recent years with increasing frequency.
For example, the Code now requires over 50 other inflation-driven computations to determine deduction, exemption and exclusion amounts in addition to the 40 separate computations needed to inflation-adjust the tax bracket tables each year. In fact, the health care reform legislation passed in 2010 adds an even greater number of inflation-adjustments to the tax code, although health-related indexing won’t start until after 2013.
Most adjustments are based on Consumer Price Index figures for September through August immediately prior to the adjusted year. However, some inflation-adjusted figures are computed later. For example, amounts such as the 2013 vehicle depreciation limits won’t be available until 2013 (the $3,160 regular first-year amount for 2012 was not released until March 2012), while the standard business mileage rate (that is currently set at 55.5 cents for 2012) isn’t expected to be computed for 2013 and released until mid-December 2012.
CCH’s projections for other indexed amounts are based on the relevant inflation data released Sept. 14, 2012, by the U.S. Department of Labor.
The IRS usually releases official numbers by December each year. CCH tax bracket projections are provided for illustrative purposes only, and should not be used for income tax returns or other federal income tax related purposes until confirmed by the IRS later this year.
Some Items Not Indexed
Jones observed that some items in the Code are not indexed for inflation and stay the same, while others rise by dollar amounts already written into the tax law.
“The exemption amounts for the alternative minimum tax (AMT) are not indexed, which means that for each year Congress must either increase the amounts by statute or expose additional households to the AMT,” Jones said.
For 2011, Congress set the AMT exemption amounts at $48,450 for single individuals and $74,450 for married couples filing jointly. Over the years Congress has relied on one-or two-year AMT “patches” to account for inflation from the initially set amounts of $33,750 and $45,000, respectively. However, there is no technical requirement under the tax code to increase those amounts for inflation. No amounts have been set for 2013, no less for 2012. While they are scheduled to revert to the default amounts of $33,750/$45,000 without action, the expectation is that Congress will once again extend the AMT exemption amounts at the higher levels.
Standard Deduction, Personal Exemption Rise
The standard deduction and personal exemption amounts are also subject to indexing; however, because of “rounding down,” some years show no change at all. 2013 will see a jump in all standard deduction levels. CCH projects that the standard deduction for single taxpayers and marrieds filing separately will increase by $150 in 2013. The standard deduction for joint filers would rise by $300, to $12,200. Heads of households will see a $250 increase to $8,950. Any increase in the standard deduction, of course, can produce lower taxes by decreasing the taxpayer’s taxable income.
The additional standard deduction for those ages 65 or older or who are blind will rise by $50 to $1,200 in 2013 for married individuals and surviving spouses, and by $50 to $1,500 for single filers. The personal exemption amount also gets bumped up by inflation by $100, to $3,900 in 2013.
However, several wrinkles may occur if the EGTRRA sunset provisions move forward. The marriage penalty relief that has been built into the standard deduction for married couples filing jointly, as well as the tax rate brackets for joint filers, will be eliminated. Rather than double the standard deduction for unmarried single filers, the 2013 standard deduction for joint filers would drop by $2,050 to $10,150, even taking the past year’s inflation into account.
For higher-income taxpayers, the limitations imposed on personal exemptions and itemized deductions based on income levels would also return in full force if EGTRRA were to sunset. Projected for inflation, those “phase-out” amounts would start for personal exemptions at $267,200 for joint filers and $178,150 for single filers and a phase-out range for itemized deductions would start at $178,150 for all filers except married couples filing separately whose phase-out range for itemized deductions starts at $89,075.
“Kiddie” Deduction, Gift Tax Exclusion
In general, inflation adjustments are rounded to the next-lower multiple of $50, so if the adjustment produces an increase of less than $50, no increase is made. The “kiddie” deduction, used on the returns of children claimed as dependents on their parents’ returns, increased only five times in the years 2001 through 2012. It last rose for the 2009 tax year. For 2013 the deduction will rise once again, to a $1,000 level.
The Code only allows the gift tax exclusion to rise when the inflation adjustment would produce an increase of $1,000 or more. The last increase occurred in 2009, when it rose to $13,000. CCH projects that it will rise to $14,000 for 2013.
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