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In November 2023, the IRS provided annual inflation adjustments for tax year 2024 for various tax provisions, including the income tax brackets, which will apply to income tax returns filed in 2025.
Tax brackets categorize taxable income into ranges. Each bracket comes with a specific tax rate. The higher your taxable income, the higher the tax bracket you fall under, and, consequently, the higher the percentage of tax you owe.
Imagine a moving staircase where the steps represent tax brackets. Inflation, not your raise, might bump you to a steep step. This means you pay more in taxes even though your buying power stays the same (or even shrinks). That's bracket creep. (View)
Bracket creep occurs when inflation, rather than real increases in income, pushes people into higher income tax brackets or reduces the value they receive from credits and deductions.
The IRS adjusts tax brackets annually to account for inflation to ensure they stay relevant. This prevents taxpayers from being pushed into higher tax brackets solely due to rising costs. The IRS previously used the Consumer Price Index (CPI) to measure inflation prior to 2018. However, with the Tax Cuts and Jobs Act of 2017 (TCJA), the IRS now uses the Chained Consumer Price Index (C-CPI) to adjust income thresholds, deduction amounts, and credit values accordingly.
The TCJA introduced significant changes to the tax code mainly cutting down individual, corporate, and estate tax rates which are set to remain in existence till 2025 until Congress decides to renew some or all of them. As a result, income tax rates will remain through 2025 but qualifying income brackets will be adjusted annually for inflation.
The corporate tax permanently became a flat rate of 21% beginning in 2018.
The federal income tax has seven tax rates in 2024: 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent.
The IRS has established seven federal income tax brackets for 2024. The following table summarizes the brackets based on filing status
As seen through the above table, the IRS’s tax system utilizes marginal tax rates. This means you only pay the higher tax rate on the portion of your income that falls within that bracket. For instance, if you're single with a taxable income of $78,750, you'll pay 10% tax on the first $11,600, 12% on the next $35,549, and 22% on the remaining $31,599.
IRS has made the inflation indexation changes to the following tax provisions as well:
Standard Deduction: Refers to the portion of income not subject to tax that can be used to reduce the tax bill.
Under federal guidelines, if you are 65 or older or you are blind, you can claim an additional standard deduction.
Alternative Minimum Tax (AMT): The AMT ensures that high-income earners pay a minimum amount of tax.
The details of other indexed credits and deductions for the year 2024 can be accessed through this link.
By understanding tax brackets and how inflation can affect them, taxpayers can be better prepared to file their tax returns and potentially reduce their tax burden.
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