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Feeling the Effects of Inflation? Learn About Inflation Adjustments and What It Could Mean For You This Tax Season

In 2022, inflation reached a 40-year high in the United States. This affected everything from groceries to gasoline; so if you found yourself wincing every time you had to fill up your car’s tank, you experienced the effects. In October, the Bureau of Labor Statistics announced that the Consumer Price Index, an average price of a basket of goods and services, was up 7.7 percent over the year before. That means that on average, the cost of what consumers bought for $100 in September 2021 inflated to $107.70 in October 2022. By comparison, economists expect to see an annual increase of about 3 percent in the average price of goods and services under ordinary circumstances. Clearly, current circumstances aren’t ordinary!

Inflation is a concern domestically and in economies around the world. Global inflation was expected to rise 8.8 percent in 2022 — a significant increase over the 4.7 percent global inflation rate in 2021, according to the International Monetary Fund.

To accommodate this rise in the cost of living, the IRS announced an inflation adjustment of 7 percent for 2022. This is more than twice 2021’s 3 percent adjustment. With prices so high, 2022’s inflation adjustment might help federal taxpayers save some money when filing their tax returns. Learn more about it below.

If price increases still make your head spin, watch this video for Understanding Inflation and How it Impacts Us.

The Purpose of an Inflation Adjustment

Inflation adjustments are intended to alleviate the strain that comes along with higher costs of living driven by inflation. The primary purpose of an inflation adjustment is to prevent “bracket creep.” Federal taxes have seven income tax brackets ranging from 10 percent to 37 percent; and without inflation adjustment, a raise you receive to keep pace with inflation could bump you into a higher tax bracket. So, you might have to pay more taxes without feeling the benefits of a higher income.

How Inflation Adjustments Work

Inflation adjustments limit the amount of revenue the government can collect as a result of inflated prices. The boundaries of income tax brackets are adjusted each year to accommodate inflation; in fact, inflation adjustments impact much of what is covered under the federal tax code. This includes tax brackets and standard deductions, as well as the Earned Income Tax Credit and estate and gift tax exclusions. Some provisions of the tax code, however, are excluded from inflation adjustments, including taxable Social Security benefits and Lifetime Learning Credit phaseouts.

The Impact of the Inflation Adjustment

News of a high inflation adjustment is welcome for taxpayers whose incomes have risen by 7 percent or less — which may be most people. In September 2022, real average earnings were down 3 percent from 2021, according to the Bureau of Labor Statistics. This may make current inflation rates challenging for the many people who struggle to meet expenses. However, this year’s inflation adjustment should offer some relief.

A version of this article appeared in our partner magazine The Essential Tax Guide: 2023 Edition.

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