How Rising Inflation Can Affect Your Federal Tax Bracket Next Year

Inflation is a word that’s been at the top of every headline and the tip of everyone’s tongue lately. And, with everyday expenses increasing in front of our eyes, many Americans are left wondering whether rampant inflation will have any long-term effects that aren’t as obvious. A good example, for instance, is how inflation affects their tax bracket.

We get it — Worrying about taxes isn’t at the top of your concerns as you run to the grocery store and pay 20% more for items than last year.

But, many Americans don’t realize how bracket creep can make a dent in their income, even if they got a big raise during the pandemic.

What Are The Current Tax Brackets?

The American federal income tax brackets are separated by percentage and filing status. Our government uses a progressive tax system, which means that as our income increases, the tax percentage increases as well.

A common misconception is that if you get a raise, you are moved up to a higher tax bracket. As you can see above, each portion of income is taxed at a set rate. When you get a raise, your additional income is taxed. So, though you will pay more in taxes, all of your income isn’t taxed at a set percentage!

Please note that your state or city may have their own tax brackets. Be sure to forget about these taxes as they will also take a portion of your gross income.

Is Inflation Bad For The Economy?

Inflation is actually good for the economy…when the percentage is small. The annual inflation sweet spot is around 2%, which incentivizes economic growth. This is what the government tries to aim for.

If consumers know goods will cost more in the future, then they’ll more likely buy products and services in the present moment.

In other words, inflation isn’t coming after your hard earned money. The issue that’s happening right now is rampant inflation. This is when inflation has quadrupled its normal rate and is even in the double digits in some industries.

With the price of essential needs and services increasing, Americans default to saving mode. Unnecessary budget spending will be heavily scrutinized and most likely be decreased.

This is the natural consequence of rampant inflation.

How Inflation Affects Tax Brackets (And Bracket Creep)

Unfortunately for many Americans, inflation can push you into higher tax brackets. This is an economic phenomenon known as bracket creep.

This issue can best be described with an example. Let’s say you’re single, and make $45,000 a year. Let’s also say that inflation is at 10% to make the math easier. Your boss matched inflation and gave you a 10% raise. Does your raise cancel out the inflation? No!!

Now, your pay raise leads you to pay additional taxes on your raise, which doesn’t match inflation.

How Does High Inflation Affect The Standard Deduction

The standard deduction is $12,950 for single filers, $25,900 for joint filers and $19,400 for heads of household (for 2022).

You can either claim the standard deduction or itemize deductions, depending on which option you pay the least amount of taxes in.

Fortunately, inflation won’t affect this part of taxes! The standard deduction is increased each year to keep up with inflation. In 2021, the standard deduction was $12,550 and in 2022, the standard deduction increased to $12,900 — a $350 difference!

How Does High Inflation Affect Retirement Accounts (IRA/401k)

Depending on when you’re aiming to retire, inflation can be a good thing for you. Stocks and bonds are assets, which tend to increase in the long-term.

If you still have a while before you retire, then inflation won’t hurt you.

However, inflation usually occurs during recessions. This means that your assets are currently down. Stocks, bonds, and other assets are currently down.

How Inflation Affects Debt (and Back Taxes)

It’s natural to think that if one owns debt, then inflation is good news. It will make your debt worth less. This is a common trap we see Americans fall into here at TaxRise.

During periods of high inflation, the government will usually raise the interest rates in order to stabilize the economy/

So despite inflation decreasing the actual worth of your debt, interest rates will negate any inflation. If you’re locked in an interest rate, this is good news for you. However, for others not in this position, this could be financially devastating.

Back taxes are an example of a debt that accumulates fast. Compounded daily, tax debt is a good example of debt you don’t want to have during times of high inflation.

The Takeaway

If you don’t know where you stand financially, check out TaxRise’s free tax consultation. From this quick call, you’ll be able to determine if you qualify for our services and which tax relief program will work best for your unique situation.

With inflation rates predicted to increase in the future, now is the best time to break free of your tax debt.

TaxRise has helped thousands of taxpayers just like you resolve their tax issues and erase their tax liability. We don’t want you crushed under cumulative interest and increasing interest rates.