Dollar Amounts and MAGI in the IRC - Are Adjustments Needed?

There are many dollar amounts in IRC sections such as for amounts of deductions, credits or exemptions, as well as for phase-out levels. The Inflation Reduction Act modifies section 30D, Clean Vehicle Credit, and adds section 25E, Previously Owned Clean Vehicle Credit. Both of these provisions have phaseout levels based on "modified AGI" and dollar limits on the cost of the car (based on MSRP for §30D, and sales price for §25E). For these credits, none of these dollar amounts are adjusted for inflation and IRA 2022 puts these credits in existence though 2032 - even though in the law for 10 years and enacted as part of the Inflation Reduction Act. 

Likely no inflation adjustments were included for these two vehicle credits because then the bill would cost more as the credit amounts would increase each year.

But is that the right answer? Perhaps. It depends. If the credit causes the supply of these cars to go up, perhaps the price will drop or won't go up as much as annual inflation adjustments. And Congress can change the dollar amount of the credit in the future.

The modified AGI definitions in these two vehicle credit provisions is AGI increased by exclusions under §911, §931 and §933 for certain foreign income exclusions. The term MAGI has varied definitions in the Code.  It appears that one reason is so an individual won't potentially lose numerous tax benefits when they cross a single definition of MAGI.

But what is the thought process on what modifications should be made to AGI?  I think most exclusions and special deductions should be added back to get at a better measure of one's income.  And the more exclusions and deductions one has, the greater is their true income. So, why not add back such items as fringe benefits including employer-provided health insurance, tax-exempt bond income, life insurance proceeds and perhaps even some portion of gifts?

And why not add back special deductions, especially ones that are likely a larger amount for higher income individuals such as the mortgage interest deduction? Or add back some portion of such deductions? Also consider that if it were instead a credit, taxable income would be higher. (Adding back deductions would also require a change to the name modified AGI.)

Since the §199A deduction is really a rate reduction, that should not be added back and charitable contributions should not be added back to encourage them.

Would it be difficult to get these figures? Some are already on the return such as tax-exempt bond interest and mortgage interest deduction. Most should be on the return to help taxpayers understand the range of tax breaks they get and the tax savings from them.

What do you think?

New Inflation Adjustments Proposed for Some Tax Rules

On July 21, Senator Grassley introduced S. 4589, Middle-Class Savings and Investment Act. It aims to add a few inflation adjustments to dollar amounts in the tax law that are not adjusted for inflation. The ones selected seem aimed at low to middle income taxpayers. These adjustments would be for:

1. $2,000 child tax credit

2. $500 other dependent credit

3. Education costs in the American Opportunity Tax Credit and Lifetime Learning Credit (currently, only the income thresholds for inflation are adjusted for inflation).

4. Student loan interest deduction.

He would pay for this by extending the $10,000 SALT cap for one more year (through 2026).

See Senator Grassley's press release about the bill.

I think there is merit in adjusting the child and dependent credits for inflation. After all, the personal exemption (returning in 2026 with the child credit going back to $1,000) was adjusted for inflation. 

I can see some logic for the education credit and student loan deduction, but these provisions already have flaws and need greater improvements and perhaps even removal from the tax law since there are non-tax laws to help low-income individuals attend college. The AOTC provides tax breaks to many individuals with income too high to qualify for a needs based scholarship. Why not use those funds to provide larger Pell grants? And these credits do cause universities to justify increased tuition (the inflation adjustments to the credit calculation would likely do the same).  And student debt has problems outside of the tax law (I highly recommend The Debt Trap by WSJ reporter Josh Mitchell).

There are numerous dollar amounts in the federal tax law that are not adjusted for inflation, such as the $3,000 capital loss limitation and the $200K and $250K thresholds for the net investment income tax (NIIT). Good for Senator Grassley in not adjusting ones that are not applicable to low to middle income taxpayers.

One that seems appropriate for his bill though is are the taxability thresholds at section 86 to determine how much Social Security might be subject to tax. That affects middle class individuals receiving Social Security benefits.

I think this topic is one warranting greater discussion in Congress as part of other needed reforms, such as whether the advanceable, fully refundable child tax credit we had for 2021 should return. That is known to have provided help to many families with income below $150,000.

What do you think?

Inflation adjustments in the tax law

Our federal tax system includes numerous dollar amounts, such as for the standard deduction amount, personal exemption amount, credits, where different tax rates start and end, and defining the parameters of a "small taxpayer."  Some of these amounts are adjusted for inflation and others are not. Should they all be? That's a good question.

I think where the tax rates of the graduated rate system start and end should be adjusted annually for inflation. This prevents "bracket creep" where a taxpayer is pushed into a higher tax bracket just because their income increased by the rate of inflation (yet their buying power and sense of wealth remained the same). The same logic calls for adjusting the standard deduction and personal exemption amounts.

Our federal income tax is not consistent regarding the need to prevent bracket creep for all taxpayers. The corporate rate structure is not adjusted for inflation. Also, the definition of "small taxpayer" such as a corporation with $5 million or less of gross receipts, is not adjusted for inflation.  They should be.

Also, dollar penalties should be adjusted for inflation to ensure they remaining meaningful penalties.

One place where I think inflation adjustments are not warranted is for thresholds for filing information returns. For example, if a business pays a contractor $600 or more for the year, the payor needs to issue Form 1099-MISC. This measure helps ensure that the contractors properly report their income. If the threshold is raised annually for inflation, fewer 1099-MISCs would be filed and the tax gap would increase.

The Tax Foundation has an interesting map showing which states adjust the income tax brackets for the effect of inflation. I'm surprised so many do not adjust.  Not adjusting for inflation generally means that the state will collect more revenue each year. Not sure that is the reason some states do not adjust the tax brackets, perhaps their system has just always been that way.

Not adjusting for inflation has caused problems at the federal level for the highway trust fund (see my post of 5/6/14).

What do you think? Should all dollar amounts  in any tax system be adjusted annually for the effect of inflation?