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Welcome to the Stay Wealthy Podcast. I'm your host, Taylor Schulte, and today I'm sharing how the recent spike in inflation might affect your tax bill. For the links and resources mentioned today, just head over to youstaywealthy.com forward slash 144. So first, just a quick personal update that my family and I are finally, finally back in our home after moving to five different houses over the last nine weeks with our three kids and a dog.
While we did make the best of it, and thanks to insurance, we stayed in some very nice rentals along the way, it just feels good to get settled and back into our home again. If you're a new listener, you can hear more about our house flood situation and some of the insurance lessons learned by checking out episode number 137, which happened to be the very last episode that aired in 2021.
Also, just about all of the Stay Wealthy sweatshirts have been mailed out and I'm loving the messages that I'm receiving from everyone. Stuart Y. said it's very high quality, just like this show. Much appreciated, Stuart. Glenda P. said that she loves it and it's keeping her warm on her daily runs.
You're awesome, Glenda. Thank you. Charlie O is thankful that he has something to keep him warm for the last few days of winter out in Las Vegas, Nevada. I'm sure it's going to be 120 degrees here soon. So enjoy that weather, Charlie. And Libby W.
didn't quite believe me when I said it was a high quality sweatshirt and not just another cheap freebie giveaway, but she confessed that she's now worn it three days in a row and even got a compliment from her husband. So thanks for the honesty Libby and really glad that you and your husband are enjoying the sweatshirt. Uh,
Thank you to everyone one more time for supporting and engaging with the show. This giveaway was just a small token of my appreciation and something that I wanted to do as a thank you over the holidays. I really wish I could have given everyone a sweatshirt, but I'll definitely be doing more giveaways and provide more opportunities to give out Stay Wealthy gear in the future. So just stay tuned.
Okay, let's get into inflation part two. And in case you missed it between today and last week's episode airing, we already saw another jump in inflation. This time inflation jumped seven and a half percent year over year.
As a reminder, these CPI reports, they come out monthly. However, the big inflation number that they're reporting and the media is recirculating that that seven and a half percent number, that's a year over year percentage change as of the most recent month end.
For example, we just wrapped up the month of January here in 2022. So the report that just came out on February 10th is measuring and reporting the 12-month percent change of inflation from January 2021 to January 2022.
In the last episode, I shared that inflation had jumped 7%, which was reporting the 12-month percent change from December 2020 to December 2021. And this does bring up a really interesting point, which is that it often makes more sense to pay closer attention to the month-by-month percent changes in inflation...
instead of the year over year, especially right now as we're coming out of this unique time period where the world shut down and consumer demand just fell off a cliff and then came roaring back again in a short period of time. By looking at the monthly numbers, you'll be able to better see if inflation is accelerating or decelerating.
For example, in October of last year, the one month percent change in just that month alone was almost 1%. In other words, prices jumped 1% in a single month due to an increase in consumer demand and prices.
But then we saw things cool down in November when the one month percent change dropped to 0.7 percent and then 0.6 percent in November, 0.6 percent again in December, and then again 0.6 percent in January. So someone analyzing the month by month percent changes in inflation might conclude that
that the rate of change is actually decelerating or flattening, which tells a very different story than the trailing 12-month inflation number, which again is 7.5% for the 12-month time period ending January 31st, 2022.
If you compare that the 7% number that I referenced in the last episode to the 7.5% number that was reported just last week, you might think that inflation is accelerating. 7.5% is higher than 7%. So inflation must be accelerating. But that's not really true. If you look at the month by month changes, you'll see that it's actually decelerated since October of last year and has started to flatten.
Unless there's a major unexpected event around the corner, I do expect this trend to continue, which means in a few months, the trailing 12-month percent change number that you see in the news will likely begin to drop as it reflects that decelerating trend and some of the extreme price increases that we saw in 2021.
As those begin to fall out of the 12 month period that we're measuring, I wouldn't be surprised to see 12 month inflation reports start to drop to the four to 5% range come summertime. And when and if that occurs, it will be interesting to see how the media begins to change their narrative on us.
So once again, be careful with those news headlines and the conclusion that they're leading you to, or that maybe you're drawing from them. We have to look under the hood. We have to dig a little bit deeper and read the fine print, especially during times of uncertainty. And for the record,
I'm not suggesting that inflation is just going to disappear and that it's nothing to worry about. I'm just saying that the spike in inflation that we saw as a result of the global pandemic and the corresponding supply-demand challenges that we experienced and we are still experiencing as a result, those will begin to normalize the 12-month inflation numbers as those get removed from that 12-month trailing number.
we could very well begin seeing a longer-term trend towards higher prices for reasons outside of the pandemic-related supply-demand issues. But given that this has been such a hot topic and one that's been very well received by all of our listeners, I will continue to revisit inflation on a periodic basis because even normal inflationary environments pose a threat to your retirement if not planned for properly.
And speaking of not planning properly, one overlooked result of the recent spike in inflation and consumer prices is how it might impact your tax bill. Because the higher inflation is, the more uneven its impact will be on taxes owed by retirement savers.
As a Wall Street Journal recently pointed out, inflation indexing began in 1981 after that long period of high inflation in the 70s which I discussed in the last episode. And that's because while wages increased with inflation during that time, tax brackets did not. Those tax brackets were fixed. As a result, Congress began indexing the income tax brackets and a few other provisions for inflation.
However, not everything has received inflation adjustments through all of this. For example, your mortgage interest deduction is capped on total mortgage debt at $750,000 across two homes. So if your total mortgage debt, whether it's on one home or two homes, if your total mortgage debt is $800,000, well, the interest that you're paying on that $50,000 above that cap is not deductible.
Unless, of course, you're grandfathered into the previous cap of $1 million before the change was made in 2017. So not only has this cap not been adjusted for inflation, but it's actually been adjusted downward, causing an increase in taxes for those with larger mortgages in high-cost housing markets. Another example of a provision that hasn't been adjusted for inflation is the capital gains exemption when selling your home.
The exemption was enacted in 1997 and is currently $250,000 for single filers and $500,000 for married couples. In other words, if you're single and you bought your home for let's say $500,000 and you sold it for $750,000,
that $250,000 profit or gain from that sale would be exempt from capital gains taxes as long as it meets some of the other basic criteria, which you can quickly look up if you're interested. Uh,
If you're married, you have $500,000 of gains that are exempt before you start paying taxes. So nice little benefit. But again, it was enacted and enacted in 1997. If this exemption was actually adjusted for inflation, it would be more like $400,000 for single filers and just over $800,000 for married couples.
This lack of inflation adjustment coupled with the skyrocketing of real estate prices and record low interest rates
It means that those who are selling their highly appreciated homes are going to get hit with a higher tax bill due to inflation. You might be wondering why this exemption hasn't changed. Well, Leonard Berman, co-founder of the Tax Policy Center, summed it up pretty well by stating that, quote, the intent was for the exemption level to decline in value over time due to inflation. Basically, it's a way of phasing in a tax increase or at least limiting the revenue costs.
Another provision that hasn't been adjusted is the 3.8% surcharge on investment income that was put in place by President Obama. This surcharge kicks in when your modified adjusted gross income, your modified AGI, when it crosses $200,000 for single filers and $250,000 for married filing jointly. The
These thresholds have not been adjusted for inflation. As a result, high earners basically get hit with a hidden tax hike every single year. Not all that different from the capital gains exemption when selling your home. The lack of inflation adjustment is a way to phase in a tax increase over time little by little.
On a more positive note, many of you in the working world will likely see an increase in pay in 2022. And that's because the inflation factor used to adjust federal tax withholding tables has increased about 3% for 2022 due to inflation indexing. And that's much higher than last year's 1% increase. The adjustment increases your take-home pay and reduces the amount of taxes that are withheld from your paycheck.
For what it's worth, the inflation adjustment of 3% might still seem a little low. And that's because there was a new method for calculating inflation adjustments in 2017, which resulted in a slower moving measure of inflation.
Also, the IRS uses inflation numbers ending August 31st for the upcoming year's tax tables. So given that the inflation spiked during the second half of last year, the adjustment that we're seeing for 2022 excludes that jump in inflation.
Next, in addition to a bump in pay, those who are contributing to retirement accounts like IRAs and 401ks, they'll benefit from the recent inflation adjustments as well. And that's because the new method for calculating inflation adjustments in 2017 that resulted in a slower moving measure of inflation was not applied to retirement account contribution limits.
In turn, retirement savers under age 50 can contribute a maximum of $20,500 to a 401k here in 2022. If you're over age 50, you can contribute up to $27,000.
That change to the limit is just over a 5% increase from the previous year. In other words, you can contribute 5% more to a 401k, i.e. a tax-advantaged account. You can contribute 5% more to that tax-advantaged account this year than last year. So thanks to inflation, you're able to save more money for retirement and benefit from a reduction in taxes.
Unfortunately, there was no increase to traditional or Roth IRAs this year as they need to be made in $1,000 increments.
Lastly, Social Security recipients are likely already aware that their benefits are getting a nice 5.9% boost, the highest increase in 40 years. However, a higher benefit also means a higher tax bill. And that's because the income thresholds for Social Security payments are not inflation adjusted.
Those thresholds have been sitting at $44,000 for married couples filing jointly and $34,000 for individuals since 1994. If they were adjusted for inflation, the thresholds would be closer to $80,000 and $62,000 respectively. Karen Smith at the Urban Institute shared that roughly 64 million adults will receive social security benefits this year and
And for about half of those recipients, their payments will be taxable. On the other hand, if those thresholds were actually adjusted for inflation, that number would get knocked down to about 24 million recipients having taxable payments.
Of course, and this likely goes without saying here, but Medicare premiums have also increased this year as they typically do. So while the bump in Social Security payments appears nice, it results in a higher tax bill for a good chunk of Americans. And that increase is also partly offset by an increase in Medicare premiums.
All right, that was a lot. So to recap and summarize the six ways inflation might impact your taxes in 2022, number one, the total mortgage interest deduction cap remains unchanged at $750,000, resulting in a higher tax bill for those in high-cost housing markets who weren't grandfathered into the prior $1 million cap.
Number two, capital gains exemption when selling your home also remains unchanged, while at the same time, real estate has skyrocketed. In short, if you're in a high-cost housing market and you sell your home, you might expect a higher tax bill. Number three, the 3.8% surcharge on investment income put in place by President Obama remains unadjusted for inflation, resulting in higher tax bills each and every year for high earners.
Number four, working professionals will likely see a bump in pay this year because the inflation factor used to adjust federal tax withholding tables has increased by about 3% for 2022. Number five, those contributing to 401ks, you can save about 5% more to your tax advantage retirement accounts this year, resulting in more money for retirement and a lower tax bill.
Number six, Social Security recipients received a nice bump in benefits this year, but it also results in more of those payments becoming taxable given that the income thresholds are not inflation adjusted. Also, the increase in Medicare premiums offset some of that bump in income.
The point of today's episode was not to drag you down and highlight mostly negative tax impacts of inflation. The point was simply to point out that inflation affects more than just the price of consumer goods and services. And to point out the importance of proactive tax planning, it's important to understand and know how your tax bill will change year over year so you can take appropriate action and start to plan ahead.
the last thing anyone wants is to get caught off guard with a larger than anticipated tax bill. Most CPAs and most high quality financial planning firms will run tax projections for you. And it's an exercise that everyone should go through at least once a year. It's been years since I've used the DIY tax prep tools like TurboTax, but my guess is that you can also run your own tax projections there as well if you don't work with a CPA or a financial planner.
All right, for all the links and resources mentioned today, just head over to youstaywealthy.com forward slash 144. Thank you as always for listening, and I will see you back here next week. This podcast is for informational and entertainment purposes only and should not be relied upon as a basis for investment decisions. This podcast is not engaged in rendering legal, financial, or other professional services.