Inflation effectively makes every dollar worth less, which impacts your spending power. That is why it is important to position your investments so they outpace inflation. To see what inflation does to the value of your money, compare the increasing cost of a $1,000 purchase over the decades.
How does inflation impact your tax bill?
Some tax provisions are indexed for inflation. Tax brackets, standard deduction amounts, and income caps on IRA contributions are adjusted yearly based on the prior year’s inflation calculations.
But two bigger tax areas that aren’t adjusted are the taxation of Social Security benefits and the home-sale exclusion. Income thresholds at which Social Security benefits are taxed have stayed static for decades despite benefits having gone up. As a result, more cumulative Social Security benefits will be taxed this year.
The home-sale exclusion has remained unchanged since 1997. Selling your home can provide a sizable tax break, but it’s never been adjusted for the appreciation in residential real estate.
Learn about the key tax provisions of the 2022 Inflation Reduction Act (Act) signed into law by the President on August 16, 2022, most of which become effective in the new year.
Several green energy tax provisions are included in the Act. Effective as of 08/16/22, only electric vehicles with parts assembled in North America qualify for the $7,500 clean vehicle credit. That means some brands of vehicles immediately lose credit eligibility because they are built abroad. The vehicle identification number will trace whether an automobile is assembled in North America.
The clean car credit was available on the first 200,000 units sold prior to the Act. But as of January 1, 2023, the cap will be lifted, and those models will qualify if bought after 2022.
Also, the Act places caps on the prices of vehicles that qualify for the credit and income limits on the taxpayer claiming the credit. Effective after 2022, passenger cars are capped at $55,000, with vans, SUVs, and trucks limited to $80,000. And the buyer’s adjusted gross income (AGI) must be below $150,000 for single ($300,000 for MFJ) to claim the credit.
Finally, the Act allows partial credits for buying a used electric vehicles. Previously, the credit was only available for new car purchases. But there are AGI limits, too ($75,000 for single filers and $150,000 for married filing jointly).
Homeowners can also receive enhanced tax breaks to help make their homes more energy efficient. Starting in 2023, up to 30% of the costs of installing Energy Star-rated doors and windows and upgrading insulation qualify for a tax credit with a total annual cap of $1,200. Previously there was a $500 lifetime credit per taxpayer.
Upgrading your A/C and appliances and completing energy audits can qualify for the credit, too. There are caps on how much you can spend on different types of improvements.
Consult your tax professional.
Inflation affects all aspects of the economy, from consumer spending, business investment and employment rates to government programs, tax policies, and interest rates.
It’s normal in a stable economy to see various price increases. However, inflation happens when prices continue to increase over a sustained period. When the demand for products and services exceeds availability, producers increases prices.
DOLLAR VALUE DECLINES
Because the amount of goods and services a given amount of money can buy falls with inflation, the dollar is less valuable. Commonly known as the time value of money, inflation decreases the value of the dollar over time, making what you have today worth less in the future.
Inflation poses a hidden threat to investors because it chips away at investment returns. Fixed income securities are especially vulnerable since the interest or coupon payment generally stays the same until maturity. That decreases the purchasing power of the interest payments as inflation rises. For example, an investment that returns 2% before inflation in an environment of 3% inflation will actually produce a negative return (-1%) when adjusted for inflation.