2006 Taxes and Inflation

Now that the 2005 tax season is over, it’s time to talk about your 2006 taxes. In the news, we often hear about “cost -of-living adjustments” and “inflation-indexed” changes to taxes. But do we understand how that affects our tax returns?

By law, a variety of tax provisions must be revised each year to keep up with inflation. As a result, more than three dozen tax benefits, affecting virtually every taxpayer, are modified for tax year 2006.

Often, the first question that a taxpayer asks is “Do my tax rates change?” Nope! The tax rates of 10%, 15%, 25%, 28%, 33%, and 35% stay the same.

It’s the tax brackets that change. The point at which each of the top five tax brackets begins is increased for inflation. The brackets are wider. So for 2006, more income will be taxed at each of the 10%, 15%, 25%, 28% and 33% rates than in 2005.

Here’s an example of tax rates and tax brackets for 2005 and 2006 tax returns.

Schedule X — Single – 2005

If taxable income is  over–

But not over–

The tax is:

$0

$7,300

10% of the amount over $0

$7,300

$29,700

$730 plus 15% of the amount over 7,300

$29,700

$71,950

$4,090.00 plus 25% of the amount over 29,700

$71,950

$150,150

$14,652.50 plus 28% of the amount over 71,950

$150,150

$326,450

$36,548.50 plus 33% of the amount over 150,150

$326,450

no limit

$94,727.50 plus 35% of the amount over 326,450

Schedule X — Single – 2006

If taxable income is  over–

But not over–

The tax is:

$0

$7,550

10% of the amount over $0

$7,550

$30,650

$755 plus 15% of the amount over 7,550

$30,650

$74,200

$4,220.00 plus 25% of the amount over 30,650

$74,200

$154,800

$15,107.50 plus 28% of the amount over 74,200

$154,800

$336,550

$37,675.50 plus 33% of the amount over 154,800

$336,550

no limit

$97,653.00 plus 35% of the amount over 336,550

You can see that many taxpayers will receive a small increase in income in 2006 before being pushed into a higher tax bracket. If you filed single for 2005, you started paying taxes at 25% when your taxable income hits $29,700. For your 2006 tax return, it’s not until your taxable income hits $30,650 that you fall into the 25% “bracket”.

For more information on the tax rate schedules for 2006, check out 2006 Tax Rate Schedules on the IRS website.

There are numerous other tax items that are adjusted for inflation such as the personal exemption has increased from $3,200 to $3,300 for tax year 2006. And the standard deduction has increased for a single taxpayer from $5,000 to $5,150.

For further details on changes for 2006, see What’s New for 2006 in the 1040 Instructions.

Now that I’ve told you all the good news dealing with inflation, there is a tax that doesn’t change with inflation….the ugly Alternative Minimum Tax (AMT). We’ll talk about AMT in my next blog.

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