If Inflation Rises, Will My Tax Bill Rise Too?

Rising inflation is famous for denoting a lowering consumer buying power. Despite inflation protections built into the tax code, it can also lead to higher individual income taxes. The impact on you and your family will depend on several factors, including your income and lifestyle.

This article will help you understand how inflation affects taxes in the Carolinas to apply solutions.

Find out how inflation factors into your retirement plan. Global View financial advisors have tax planning strategies fit for your financial life.

What Happens When Inflation Rises?

When inflation rises, you will have to hand over more money to pay for the same goods and services. Why? Because your dollar is not worth what it was before inflation heated up. In other words, your money is less valuable.

You can experience some benefits when your income and assets (like your home and stocks) gain value due to inflation. However, higher prices and taxes may negate the positive impacts.

Some of the significant aspects of rising inflation include:

Higher prices on goods and services.

Have you been to the gas pump lately? You will pay more for food, transportation, rent, prescriptions, and dozens of other spending items.

Higher interest rates.

These are great for savings accounts with variable interest rates and borrowings with fixed interest rates. It’s terrible for new borrowers, holders of fixed-interest securities, and those repaying variable-interest loans.

Higher prices on certain assets.

You will surely benefit from selling an asset at an inflated price, like a used vehicle. But if you are relocating from one home to another, inflation may generate higher home-purchase prices that eat up the inflationary gains on your old home.

Lower values on other assets.

Fixed income investments lose value during inflation because they can’t increase the interest they pay. This limitation adversely affects your CDs, fixed-rate bonds, and pensions.

Higher retirement target amounts.

As inflation rises, the value of your retirement account recedes. To compensate, you must raise the target amount you need to retire with the desired lifestyle. You might accomplish this by contributing more each year until retirement and/or shifting to higher risk/higher return investments, both of which have their downsides.

Rationing.

Sometimes, inflation occurs because too much money pursues too few goods. The results are scarcities, higher prices, and rationing. If you begin building a home during this type of inflation, you may face substantial delays when ordering materials and supplies. It may also be challenging to find contractors who aren’t fully booked.

Read: 6 Ways to Help Stretch Your Retirement Money Longer

Bills vs. Inflation

Your personal inflation is not the same as the change to the Consumer Price Index (CPI – the federal government’s inflation gauge). That’s because the CPI monitors price changes on a broad basket of goods and services. You, however, have specific bills for specific items.

Your spending does not mirror the CPI basket—the effects of inflation are individual to you.

For example, you are less impacted by high gasoline prices if you don’t drive a car or commute to work. However, if you are a self-employed truck driver, higher gasoline prices are a hardship far exceeding the damage implied by the change in prices to the CPI basket. The same is true if you own and use a boat or airplane.

What Does Inflation Mean for My Tax Bill?

The IRS tries to reduce inflation’s sting by indexing certain items to inflation. In 2022, these include:

Federal income tax brackets
Standard deductions
The contribution limits for 401(k)s, health flexible spending arrangements, and medical savings accounts
Social Security benefits and adjusted earnings history
The tax exemption for the Alternative Minimum Tax
The maximum Earned Income Tax Credit
The monthly limitation for qualified transportation and parking fringe benefits
The foreign earned income exclusion
The exclusion from estate and gift taxes
The credit for qualified adoption expenses

While this list is impressive, it ignores certain other 2022 tax items that the IRS doesn’t adjust, including:

The $500,000 exclusion ($250,000 for single filers) of capital gains from the sale of your primary home, subject to ownership and use tests
The $750,000 cap on deductible mortgage interest
The thresholds for taxes on Social Security benefits
The thresholds for the 3.8% surcharge on investment income. This tax kicks in when modified adjusted gross income exceeds $250,000 for married couples $200,000 for single filers
The $10,000 federal deduction limit for state and local taxes (SALT) — Example: this applies to South Carolina residents who pay more than $10,000 in state and local income tax

Congress can change any of these items in 2022. For example, discussions continue regarding a higher deduction limit for SALT.

What Can I Do to Avoid the Rise in Tax Bill?

The most straightforward way to keep inflation from boosting your tax bill is to limit increases to your modified adjusted gross income.

For example, in 2021, a married couple’s marginal tax bracket was 24% for income between $172,751 and $329,850. In 2022, that same couple’s 24% tax bracket applied to income between $178,150 and $340,100. If inflation helped the couple pull in more revenue in 2022, they could avoid entering the 32% bracket by keeping their MAGI below $340,100.

Besides keeping a lid on your income, you can reduce MAGI by increasing your “above-the-line” income adjustments on your tax return. The line in question is Line 11, adjusted gross income (AGI), on Form 1040. You report adjustments to income that reduce AGI on Schedule 1, including:

Contributions to IRAs and self-employed qualified retirement plans
Educator expenses
Certain business expenses
Health savings account contributions
Armed Forces moving expenses
Part of your self-employment tax
Self-employed health insurance premiums
Paid alimony
Student loan interest
Medical savings account contributions

MAGI is the amount resulting from certain add-backs to AGI, including:

Foreign earned income
Student loan interest
The excluded portion of adopting expenses

You can reduce your taxes by postponing your Social Security benefits, avoiding the 3.8% surtax by keeping MAGI below $200,000 ($250,000 for couples), and reporting all your AGI adjustments and state and local taxes. You can save on taxes through charitable contributions by itemizing the deductions (on Schedule A).

How Can An Advisor Help?

Our firm of investment advisors in Greenville, SC, wants you to be aware of the tax impacts caused by inflation. Our Global View team can help you develop and refine your financial plans to accommodate inflation, no matter how high or low. Your current lifestyle doesn’t have to change with the right tax advice.

In addition, our Carolina retirement planners can work with you to protect your nest egg from the long-term inflation impacts. Moreover, our tax advisors will show you how to minimize your tax payment this season—it will also help you get an early handle on next year's taxes.

We do not sell—we provide personalized advice. We are never paid by our investment providers and always put your needs before our own! That is our ethical duty and promise. Call us today to work with Global View Investment Advisors, a fee-only, fiduciary firm serving the Carolinas.

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