Tax Analysts®Tax Analysts®

My Subscriptions:

Featured News

October 16, 2007
Inflation Adjustments Affecting Individual Taxpayers in 2008
by James C. Young

Full Text Published by Tax Analysts®

Document originally published in Tax Notes Today
on October 16, 2007.

Without inflation adjustments to key portions of the tax system, individuals would be faced with an erosion of their purchasing power. In 1985 Congress implemented an indexation procedure to adjust various income tax components, including the tax rate schedules, standard deduction, and personal and dependency exemptions. Although suspended by the Tax Reform Act of 1986, indexation resumed in 1989 and now applies to many items in the tax system.

In this article, Young discusses 2008 inflation adjustments to portions of the individual tax system that are tied to a Consumer Price Index year ending in August. Items adjusted by this indexation procedure include the tax rate schedules; standard deductions; exemptions (and related phaseout); the overall limit on itemized deductions; the annual gift tax exclusion; and some computational elements related to the unearned income of minor children, the child credit, the earned income tax credit, adoption expenses, educational savings bonds, education credits, education loan interest, qualified transportation fringe benefits, medical savings accounts (Archer MSAs), health savings accounts, long-term care insurance premiums, long-term care insurance benefits, and the section 179 expense election.


Copyright 2007 James C. Young.
All rights reserved.

* * * * *

Table of Contents


Introduction

2008 Inflation Adjustments

Standard Deduction and Exemption Amounts

Tax Rate Schedules

Overall Limitation on Itemized Deductions

Annual Gift Tax Exclusion

Unearned Income of Minor Children

Child Tax Credit

Earned Income Tax Credit

Adoption Expenses Credit and Exclusion

Educational Savings Bonds

HOPE Scholarship and Lifetime Learning Credits

Education Interest Expense

Qualified Transportation Fringe Benefits

Medical Savings Accounts

Health Savings Accounts

Long-Term Care Insurance Premiums

Long-Term Care Insurance Benefits

Traditional IRA Contribution Limits and Phaseouts

Roth IRA Contribution Limits and Phaseouts

Section 179 Expensing

Five-Year Summary of Key Information

Conclusion


Introduction


Some provisions of the Internal Revenue Code are structured to reflect the impact of inflation. Those provisions require reference to non-IRC information (that is, a cost-of-living index) to make the computations. Indexation and taxation generally became intertwined in the Economic Recovery Tax Act of 1981. Because inflation erodes the value of the various fixed dollar amounts specified in the IRC to determine tax liability, Congress enacted inflation adjustment mechanisms for several provisions. The number of IRC provisions subject to inflation adjustment continues to expand. Also, the manner in which calculations are made often differs across the IRC provisions. This article provides information related to inflation adjustments based on a Consumer Price Index year ending in August.

The measure used most often for making adjustments to amounts specified in the IRC is the Consumer Price Index for All-Urban Consumers (CPI-U). The index, issued monthly by the Bureau of Labor Statistics, is intended to reflect changes in a market basket of goods and services purchased by consumers, and the weighting factors for items in the market basket. The CPI reports changes in prices for a fixed group of items rather than the amount of money spent. It is based on the assumption that the same items in the market basket are purchased in the same proportions (or weight) month after month. Technically, it is a price index rather than a cost-of-living index.


2008 Inflation Adjustments


The annual inflation adjustments are determined by examining the increase in the CPI-U (section 1(f)(5)). The increase in CPI is determined by comparing the average CPI for any 12-month period ending August 31 with the average CPI for the appropriate base period specified by statute. The following table summarizes the various base periods and their related CPIs:

 Adjustment
 
                                   Base Period Is                 First Occurs
 
                                    the 12-Month       Base       in Calendar
 
Item                               Period Ending    Period CPI      Year
 ______________________________________________________________________________

 Standard deduction                August 31, 1987   111.9833333     1989
 Unearned income of minor child    August 31, 1987   111.9833333     1989
   (base amount)
 Exemptions                        August 31, 1988   116.6166667     1990
 Educational savings bonds         August 31, 1989   122.1500000     1991
 Exemption phaseout                August 31, 1990   128.0583333     1992
 Itemized deduction limitation     August 31, 1990   128.0583333     1992
    (3% of AGI)
 Tax rate schedules:
   10% bracket                     August 31, 2002   178.6750000     2004
   15%/25%/28% brackets            August 31, 1992   138.9250000     1994
   33%/35% brackets                August 31, 1993   143.1750000     1995
 Earned income credit              August 31, 1995   151.0750000     1997
 Standard deduction for employed   August 31, 1997   159.4916667     1999
   dependents
 Medical Savings Accounts          August 31, 1997   159.4916667     1999
 Annual gift tax exclusion         August 31, 1997   159.4916667     1999
 Qualified transportation fringe benefits:
   Categories 1 and 2              August 31, 2001   175.8750000     2003
   Category 3                      August 31, 1998   162.1833333     2000
 HOPE, lifetime learning, and      August 31, 2000   170.3083333     2002
   child tax credits
 Education loan interest           August 31, 2001   175.8750000     2003
 Adoption expenses/credit          August 31, 2001   175.8750000     2003
 Traditional and Roth IRA          August 31, 2005   192.7666667     2007
   income phaseouts
 Section 179 expense amounts       August 31, 2006   200.2916667     2008

2008 Inflation Factors. For the 12-month period ended August 31, 2007, the average CPI is 204.8725000. As a result, the 2008 inflation factors are as follows:

 Inflation
 
                                                                  Adjustment
 
                                                                    Factor
 
                                                                  [1 + (CPI
 
                                                                  Difference/
 
Item                                 CPI Difference               Base Period
 
                                                                     CPI)]
 ______________________________________________________________________________

 Standard deduction        204.8725000 - 111.9833333 = 92.8891667    1.8294910
 Unearned income of        204.8725000 - 111.9833333 = 92.8891667    1.8294910
   minor child
   (base amount)
 Exemptions                204.8725000 - 116.6166667 = 88.2558333    1.7568029
 Educational savings       204.8725000 - 122.1500000 = 82.7225000    1.6772206
   bonds
 Exemption phaseout        204.8725000 - 128.0583333 = 76.8141667    1.5998373
 Itemized deduction        204.8725000 - 128.0583333 = 76.8141667    1.5998373
   limitation
   (3% of AGI)
 Tax rate schedules:
   10% rate bracket        204.8725000 - 178.6750000 = 26.1975000    1.1466210
   15%/25%/28% brackets    204.8725000 - 138.9250000 = 65.9475000    1.4746986
   33%/35% brackets        204.8725000 - 143.1750000 = 61.9750000    1.4309237
 Earned income credit      204.8725000 - 151.0750000 = 53.7975000    1.3560980
 Standard deduction for    204.8725000 - 159.4916667 = 45.3808333    1.2845342
   employed dependents
 Medical Savings           204.8725000 - 159.4916667 = 45.3808333    1.2845342
   Accounts
 Annual gift tax           204.8725000 - 159.4916667 = 45.3808333    1.2845342
   exclusion
 Qualified transportation fringe benefits:
   Categories 1 and 2      204.8725000 - 175.8750000 = 28.9975000    1.1648756
   Category 3              204.8725000 - 162.1833333 = 42.6891667    1.2632155
 HOPE, lifetime learning,  204.8725000 - 170.3083333 = 34.5641667    1.2029505
   and child tax credits
 Education loan interest   204.8725000 - 175.8750000 = 28.9975000    1.1648756
 Adoption expenses/credit  204.8725000 - 175.8750000 = 28.9975000    1.1648756
 Traditional and Roth IRA  204.8725000 - 192.7666667 = 12.1058333    1.0628004
   income phaseouts
 Section 179 expense       204.8725000 - 200.2916667 = 4.5808333     1.0228708
   amounts

Those factors are applied to specified dollar amounts in the appropriate IRC provision. Rounding conventions differ and are specified by statute.



Standard Deduction and Exemption Amounts


According to section 1(f) (and sections 63(c)(4) and 151(d)(3)), the standard deduction and exemption amounts are to be adjusted by the appropriate CPI increase (section 1(f)(5)). Any increases computed for those items are rounded down to the nearest $50 multiple ($25 for married, filing separate) (section 1(f)(6)). Similar adjustments are made to the adjusted gross income amounts used to phase out exemptions.

Standard Deduction Amounts. The standard deduction amounts specified by section 63(c) are adjusted annually for inflation. The standard deduction for married taxpayers filing a joint return is specified by law to be twice the standard deduction for single taxpayers (section 63(c)(2)). After adjustment, the 2008 standard deduction amounts will be as follows (2007 amounts for comparison):

 2008        2007
 ______________________________________________________________________________

 Single individual                                    $5,450      $5,350
 Married, filing jointly, and surviving
   spouse                                             10,900      10,700
 Head of household                                     8,000       7,850
 Married, filing separately                            5,450       5,350

Additional Standard Deductions for Elderly and Blind. For a taxpayer (and spouse) who is elderly (age 65 or over) or blind, the following applies (section 63(f)):

    • Unmarried Taxpayer: An additional $1,350 (up from $1,300 in 2007) standard deduction is allowed ($2,700 for a taxpayer who is both elderly and blind).
    • Married Taxpayer: An additional $1,050 (unchanged from 2007) standard deduction is allowed ($2,100 for a taxpayer who is both elderly and blind).

Limitation for Dependents.
If an individual may be claimed as a dependent on another taxpayer's return, the basic standard deduction is limited (section 63(c)(5)). For dependents with earned income (but total income less than the basic standard deduction), a slightly increased standard deduction (of up to $250) is available. Both the limited standard deduction ($500) and the additional earned income standard deduction ($250) are indexed annually for inflation. In 2008 a dependent's basic standard deduction is limited to the lesser of:

      1. The basic standard deduction for single taxpayers ($5,450); or

      2. The greater of:


          a. $900 (up from $850 in 2007); or

          b. the dependent's earned income plus $300 (unchanged from 2007).

In 2007 a dependent's basic standard deduction is limited to the lesser of:

      1. The basic standard deduction for single taxpayers ($5,350); or

      2. The greater of:


          a. $850 (unchanged from 2006); or

          b. the dependent's earned income plus $300 (unchanged from 2006).

Exemption Amount. After adjusting for inflation, the 2008 exemption amount will be $3,500 (up from $3,400 in 2007). The 1989 exemption amount of $2,000 is used as the base.

Exemption Phaseout. Exemption amounts claimed on a tax return are subject to a phaseout when the taxpayer's AGI exceeds a threshold amount (section 151(d)(3)). All exemption amounts claimed on a return are reduced by 2 percent for each $2,500 (or fraction thereof) of AGI in excess of the appropriate threshold amount ($1,250 for a married individual filing separately). As a result, exemption deductions are completely eliminated when AGI exceeds the AGI threshold amount by more than $122,500 ($61,250 for a married individual filing separately). The AGI threshold amounts for 2008 will be as shown in the table below (2007 amounts for comparison).

 2008                        2007
                             Phaseout     Phaseout     Phaseout     Phaseout
                             Begins When  Completed    Begins When  Completed
                             AGI          When AGI     AGI          When AGI
 Exemption Phaseout          Exceeds      Exceeds      Exceeds      Exceeds
 ______________________________________________________________________________


 Single individual           $159,950     $282,450     $156,400     $278,900
 Married, filing jointly,     239,950      362,450      234,600      357,100
   and surviving spouse
 Head of household            199,950      322,450      195,500      318,000
 Married, filing separately   119,975      181,225      117,300      178,550


This phaseout is gradually being eliminated. In 2008 and 2009, the phaseout will be reduced by two-thirds (in 2006 and 2007, it was reduced by one-third), and it will be completely eliminated in 2010.


Tax Rate Schedules


The minimum and maximum dollar amounts for each rate bracket (section 1(a) through (e)) are adjusted for inflation annually (section 1(f)(6)). Any increases computed for those items are rounded down to the nearest $50 multiple ($25 for married, filing separate). The 2008 tax rate schedules appear in Table 1; the 2007 tax rate schedules are presented in Table 2.

Overall Limitation on Itemized Deductions

Total itemized deductions otherwise allowable are reduced by 3 percent of a taxpayer's AGI in excess of specified threshold amounts (section 68). This overall limitation applies to itemized deductions after all other floors have been applied. After application of the 3 percent floor, the net itemized deductions remain.

 Table 1. 2008 Tax Rate Schedules
 _____________________________________________________________________________

                             
Single (Section 1(c)):
 _____________________________________________________________________________

 If taxable income is:                  The tax is:

   Not over $8,025                        10% of taxable income
   Over $8,025 but not over $32,550       $802.50, plus 15% of the excess
                                            over $8,025
   Over $32,550 but not over $78,850      $4,481.25, plus 25% of the excess
                                            over $32,550
   Over $78,850 but not over $164,550     $16,056.25, plus 28% of the excess
                                            over $78,850
   Over $164,550 but not over $357,700    $40,052.25, plus 33% of the excess
                                            over $164,550
   Over $357,700                          $103,791.75, plus 35% of the excess
                                            over $357,700
 _____________________________________________________________________________

                       
Head of Household (Section 1(b)):
 _____________________________________________________________________________

 If taxable income is:                  The tax is:

   Not over $11,450                       10% of taxable income
   Over $11,450 but not over $43,650      $1,145.00, plus 15% of the excess
                                            over $11,450
   Over $43,650 but not over $112,650     $5,975.00, plus 25% of the excess
                                            over $43,650
   Over $112,650 but not over $182,400    $23,225.00, plus 28% of the excess
                                            over $112,650
   Over $182,400 but not over $357,700    $42,755.00, plus 33% of the excess
                                            over $182,400
   Over $357,700                          $100,604.00, plus 35% of the excess
                                            over $357,700
 _____________________________________________________________________________

         
Married, Filing Jointly, and Surviving Spouse (Section 1(a)):
 _____________________________________________________________________________

 If taxable income is:                  The tax is:

   Not over $16,050                       10% of taxable income
   Over $16,050 but not over $65,100      $1,605.00, plus 15% of the excess
                                            over $16,050
   Over $65,100 but not over $131,450     $8,962.50, plus 25% of the excess
                                            over $65,100
   Over $131,450 but not over $200,300    $25,550.00, plus 28% of the excess
                                            over $131,450
   Over $200,300 but not over $357,700    $44,828.00, plus 33% of the excess
                                            over $200,300
   Over $357,700                          $96,770.00, plus 35% of the excess
                                            over $357,700
 _____________________________________________________________________________

                   
Married, Filing Separately (Section 1(d)):
 _____________________________________________________________________________

 If taxable income is:                  The tax is:

   Not over $8,025                        10% of taxable income
   Over $8,025 but not over $32,550       $802.50, plus 15% of the excess
                                            over $8,025
   Over $32,550 but not over $65,725      $4,481.25, plus 25% of the excess
                                            over $32,550
   Over $65,725 but not over $100,150     $12,775.00, plus 28% of the excess
                                            over $65,725
   Over $100,150 but not over $178,850    $22,414.00, plus 33% of the excess
                                            over $100,150
   Over $178,850                          $48,385.00, plus 35% of the excess
                                            over $178,850
 _____________________________________________________________________________

                       
Estates and Trusts (Section 1(e)):
 _____________________________________________________________________________

 If taxable income is:                  The tax is:

   Not over $2,200                       15% of taxable income
   Over $2,200 but not over $5,150       $330.00, plus 25% of the excess
                                           over $2,200
   Over $5,150 but not over $7,850       $1,067.50, plus 28% of the excess
                                            over $5,150
   Over $7,850 but not over $10,700      $1,823.50, plus 33% of the excess
                                            over $7,850
   Over $10,700                          $2,764.00, plus 35% of the excess
                                            over $10,700


Threshold Amount. For 2008 the threshold amount is $159,950 for all taxpayers except a married individual filing separately, whose threshold is $79,975. For 2007 the threshold amount is $156,400 for all taxpayers except a married individual filing separately, whose threshold is $78,200.

This limitation is gradually being eliminated. In 2008 and 2009, the limitation will be reduced by two-thirds (in 2006 and 2007, it was reduced by one-third), and will be completely eliminated in 2010.


Annual Gift Tax Exclusion


Since 1999 the annual gift tax exclusion is subject to an inflation adjustment, with any increase rounded down to the nearest $1,000 multiple (section 2503(b)). The 1998 exclusion amount of $10,000 is used as the base. For 2008 the annual gift tax exclusion will be $12,000 (unchanged from 2007).

Unearned Income of Minor Children

The federal tax liability of a minor child having gross income is computed in the same manner as any other taxpayer. However, intrafamily transfers of income-producing property will not reduce the family's overall income tax liability by shifting income from the parents' (generally higher) marginal tax rate to a child's (generally lower) tax bracket. Instead, the "net unearned income" of a minor child (section 1(g)(2)) is taxed at the parents' marginal tax rate (section 1(g) and reg. section 1.1(i)-1T).

 Table 2. 2007 Tax Rate Schedules
 _____________________________________________________________________________

                             
Single (Section 1(c)):
 _____________________________________________________________________________

 If taxable income is:                  The tax is:

   Not over $7,825                        10% of taxable income
   Over $7,825 but not over $31,850       $782.50, plus 15% of the excess
                                            over $7,825
   Over $31,850 but not over $77,100      $4,386.25, plus 25% of the excess
                                            over $31,850
   Over $77,100 but not over $160,850     $15,698.75, plus 28% of the excess
                                            over $77,100
   Over $160,850 but not over $349,700    $39,148.75, plus 33% of the excess
                                            over $160,850
   Over $349,700                          $101,469.25, plus 35% of the excess
                                            over $349,700
 _____________________________________________________________________________

                       
Head of Household (Section 1(b)):
 _____________________________________________________________________________

 If taxable income is:                  The tax is:

   Not over $11,200                       10% of taxable income
   Over $11,200 but not over $42,650      $1,120.00, plus 15% of the excess
                                            over $11,200
   Over $42,650 but not over $110,100     $5,837.50, plus 25% of the excess
                                            over $42,650
   Over $110,100 but not over $178,350    $22,700.00, plus 28% of the excess
                                            over $110,100
   Over $178,350 but not over $349,700    $41,810.00, plus 33% of the excess
                                            over $178,350
   Over $349,700                          $98,355.50, plus 35% of the excess
                                            over $349,700
 _____________________________________________________________________________

         
Married, Filing Jointly, and Surviving Spouse (Section 1(a)):
 _____________________________________________________________________________

 If taxable income is:                  The tax is:

   Not over $15,650                       10% of taxable income
   Over $15,650 but not over $63,700      $1,565.00, plus 15% of the excess
                                            over $15,650
   Over $63,700 but not over $128,500     $8,772.50, plus 25% of the excess
                                            over $63,700
   Over $128,500 but not over $195,850    $24,972.50, plus 28% of the excess
                                            over $128,500
   Over $195,850 but not over $349,700    $43,830.50, plus 33% of the excess
                                            over $195,850
   Over $349,700                          $94,601.00, plus 35% of the excess
                                            over $349,700
 _____________________________________________________________________________

                   
Married, Filing Separately (Section 1(d)):
 _____________________________________________________________________________

 If taxable income is:                  The tax is:

   Not over $7,825                        10% of taxable income
   Over $7,825 but not over $31,850       $782.50, plus 15% of the excess
                                            over $7,825
   Over $31,850 but not over $64,250      $4,386.25, plus 25% of the excess
                                            over $31,850
   Over $64,250 but not over $97,925      $12,486.25, plus 28% of the excess
                                            over $64,250
   Over $97,925 but not over $174,850     $21,915.25, plus 33% of the excess
                                            over $97,925
   Over $174,850                          $47,300.50, plus 35% of the excess
                                            over $174,850
 _____________________________________________________________________________

                       
Estates and Trusts (Section 1(e)):
 _____________________________________________________________________________

 If taxable income is:                  The tax is:

   Not over $2,150                        15% of taxable income
   Over $2,150 but not over $5,000        $322.50, plus 25% of the excess
                                            over $2,150
   Over $5,000 but not over $7,650        $1,035.00, plus 28% of the excess
                                            over $5,000
   Over $7,650 but not over $10,450       $1,777.00, plus 33% of the excess
                                            over $7,650
   Over $10,450                           $2,701.00, plus 35% of the excess
                                            over $10,450


Net Unearned Income. The net unearned income computation contains a base amount that is subject to an inflation adjustment each year. Also, the computation allows a subtraction for a portion (or all) of the child's standard deduction (also subject to an inflation adjustment, discussed above). For 2008, net unearned income is computed as follows (section 1(g)(4)):

 Unearned Income
 Less:       $900 (up from $850 in 2007)

 Less:       The
greater of:
             (1) $900 of the standard deduction (or $900 of
             itemized deductions) (up from $850 in 2007)

             
OR

             (2) The amount of allowable deductions that
             are directly connected with the production of
             the unearned income
             _____________________________________________________________
 Equals:     Net Unearned Income


If net unearned income is $0 (or negative), the child's tax is computed without regard to this provision.

Election to Place Unearned Income on Parent's Return. If specified requirements are met (section 1(g)(7)(A)), a parent may elect to include the unearned income of a minor child on his return (section 1(g)(7)). Form 8814 is used to make the election. Making the election eliminates the need for the child to file a tax return. The section 1(g)(7) election amounts are linked to the inflation-adjusted amounts used in computing net unearned income (section 1(g)(4)).

In 2008 the section 1(g)(7) election can be made if a child has gross income (exclusively from interest and dividends) between $900 and $9,000 (up from between $850 and $8,500 in 2007) and the other requirements of section 1(g)(7)(A) are met. In 2008 the tax on a child's first $1,800 of unearned income will be the lesser of $90 ($900 x 10 percent) or 10 percent of unearned income exceeding $900. If the child has unearned income in excess of $1,800, it will be taxed at the parent's highest marginal tax rate.

Alternative Minimum Tax Exemption. Minor children with unearned income face a reduced alternative minimum tax exemption amount (section 59(j)). In general, the AMT exemption is limited to the child's earned income plus $5,000 (but no more than the AMT exemption for single taxpayers). The $5,000 amount is subject to an annual inflation adjustment and rounded to the nearest $50 multiple. In 2008 the addition to earned income will be $6,400 (up from $6,300 in 2007).


Child Tax Credit


The child tax credit provisions allow taxpayers to take a tax credit based on the number of eligible dependent children (section 24). The child tax credit is $1,000 per child. For higher-income taxpayers, the available credit begins to phase out when AGI reaches $110,000 for married couples filing a joint return, $55,000 for married couples filing separately, and $75,000 for all other taxpayers. Those threshold amounts are not indexed for inflation. For lower-income taxpayers, the child tax credit is refundable for up to 15 percent of the taxpayer's earned income in excess of $10,000 (section 24(d)). The $10,000 earned income floor is adjusted for inflation each year and rounded to the nearest $50 multiple. For 2008 the earned income floor is $12,050 (up from $11,750 in 2007).

Earned Income Tax Credit

The earned income tax credit authorized by section 32 is determined by multiplying an inflation-adjusted maximum amount of earned income by a specified credit percentage (based on the number of qualifying children). The credit is reduced by a specified percentage of income over an inflation-adjusted phaseout amount. For married taxpayers filing a joint return, the phaseout base amount is increased by $2,000 in 2005 through 2007, and $3,000 in 2008. The $3,000 base amount increase will be adjusted for inflation beginning in 2009. The income used for this phaseout is the greater of a taxpayer's AGI or earned income. Finally, investment income in excess of an inflation-adjusted target disqualifies an individual from the EITC (section 32(i)(1) and (2)).

The maximum earned income and phaseout base amounts (which are to be used for inflation adjustment purposes) are specified in section 32(b)(2). Base amounts determined in the inflation calculations are then rounded to the nearest $10 multiple. The inflation-adjusted disqualified income amount is rounded down to the nearest $50 multiple.

The EITC percentages and phaseout percentages are specified in section 32(b)(1). The earned income base amounts and phaseout information for 2008 and 2007 are indicated in the table below.

 Earned
 
             Number of                Income
 
Tax         Qualifying                 Base         Credit         Maximum
 
Year         Children                 Amount      Percentage        Credit
 ___________________________________________________________________________

 2008    
Married, Filing Jointly:
         No children                   $5,720          7.65            $438
         One child                      8,580         34.00           2,917
         Two or more children          12,060         40.00           4,824
         
Other Taxpayers:
         No children                   $5,720          7.65            $438
         One child                      8,580         34.00           2,917
         Two or more children          12,060         40.00           4,824
 ___________________________________________________________________________

 2007    
Married, Filing Jointly:
         No children                   $5,590          7.65            $428
         One child                      8,390         34.00           2,853
         Two or more children          11,790         40.00           4,716
         
Other Taxpayers:
         No children                   $5,590          7.65            $428
         One child                      8,390         34.00           2,853
         Two or more children          11,790         40.00           4,716
 ___________________________________________________________________________

                               [Table continued]
 ___________________________________________________________________________
                                                                   
Phaseout
 
Tax                                  Phaseout      Phaseout        Ends at
 
Year                                   Base       Percentage      Income of
 ___________________________________________________________________________

 2008    
Married, Filing Jointly:
         No children                  $10,160          7.65         $15,880
         One child                     18,740         15.98          36,995
         Two or more children          16,740         21.06          41,646
         
Other Taxpayers:
         No children                   $7,160          7.65         $12,880
         One child                     15,740         15.98          33,995
         Two or more children          15,740         21.06          38,646
 ___________________________________________________________________________

 2007    
Married, Filing Jointly:
         No children                   $9,000          7.65         $14,590
         One child                     17,390         15.98          35,241
         Two or more children          17,390         21.06          39,783
         
Other Taxpayers:
         No children                   $7,000          7.65         $12,590
         One child                     15,390         15.98          33,241
         Two or more children          15,390         21.06          37,783

In 2008 the section 32(i) disqualified income amount will be $2,950 (up from $2,900 in 2007).


Adoption Expenses Credit and Exclusion


If a taxpayer incurs expenses related to the adoption of a qualified child (for example, adoption fees, attorney and court costs, social service review costs, and transportation costs), an adoption expenses credit is available (section 23). The tax credit covers the first $10,000 of adoption expenses paid by a taxpayer. The available credit is phased out ratably over a range of $40,000 for taxpayers whose modified AGI (section 23(b)(2)(B)) exceeds $150,000. Both the $10,000 ceiling on qualified expenses and the $150,000 modified AGI phaseout target are adjusted annually for inflation (and rounded to the nearest $10 multiple). In 2008 the first $11,650 of adoption expenses will qualify for the credit (up from $11,390 in 2007) and the credit will begin to phase out when a taxpayer's AGI exceeds $174,730 (up from $170,820 in 2007).

If employers provide adoption assistance, an income exclusion is available to the employee. In 2008 the total income exclusion available is $11,650 per child (up from $11,390 in 2007).


Educational Savings Bonds


Interest income earned on a qualified U.S. Series EE savings bond used to finance the higher education of the taxpayer, spouse, or dependents is excluded from gross income (section 135). The exclusion (reported on Form 8815) applies to savings bonds purchased and redeemed in tax years beginning after December 31, 1989. No exclusion is allowed to married individuals filing separate returns.

If the principal and interest amounts received do not exceed the qualified higher education expenses, all interest is excludable subject to an inflation-adjusted modified AGI phaseout. If the principal and interest amounts received exceed the qualified higher education expenses, only a pro rata portion of the interest will qualify for the exclusion (the ratio of qualified higher education expenses to total principal and interest received).

Phaseout of Benefit. The tax exclusion is subject to a phaseout that is tied to the taxpayer's modified AGI (section 135(c)(4)). The excludable interest is reduced (but not below zero) by applying the following formula:

 Modified AGI - AGI Base
 
Excludable Interest  X  ____________________________
 
                        $15,000 ($30,000 for married,
 
                        filing jointly)

When modified AGI exceeds the AGI base, the exclusion is completely phased out. The AGI bases (section 135(b)(2)(A)); $60,000 for married, filing jointly; $40,000 for single and head of household) are adjusted for inflation, with the adjusted amounts rounded to the nearest $50 multiple. The AGI base amounts for 2008 and 2007 are:

 2008        2007
 ______________________________________________________________________________

 Married, filing jointly                            $100,650    $98,400
 Single (including head of household)                $67,100     $65,600


HOPE Scholarship and Lifetime Learning Credits


The HOPE scholarship credit and the lifetime learning credit are available to help qualifying individuals defray the cost of higher education (section 25A). Those nonrefundable credits are available for qualifying expenses (tuition and related expenses; not room, board, or books) for eligible students (section 25A(b)(3)) pursuing undergraduate or graduate degrees or vocational training.

The HOPE scholarship credit is available during an eligible student's first two years of postsecondary education. The $1,000 qualifying expense base (section 25A(b)(1)) that is part of the credit is adjusted for inflation and rounded down to the nearest $100 multiple. For 2008 the base increases to $1,200 (up from $1,100 in 2007). As a result, the maximum HOPE scholarship credit in 2008 is $1,800 (100 percent of the first $1,200 of qualifying expenses and 50 percent of the next $1,200) — up from $1,650 in 2007 (100 percent of the first $1,100 of qualifying expenses and 50 percent of the next $1,100).

The lifetime learning credit is available to eligible students when the HOPE credit is not available. In 2008 the lifetime learning credit is 20 percent of the first $10,000 of qualifying expenses. The qualifying expense limit is not subject to an annual inflation adjustment.

Phaseout of Credits. Both education credits are subject to a phaseout that is tied to the taxpayer's modified AGI (section 25A(d)(3)). The combined education credits are reduced by applying the following formula:

 Modified AGI - AGI Base
 
Education Credits   X   _____________________________
 
                        $10,000 ($20,000 for married,
 
                        filing jointly)

The AGI bases (section 25A(d)(2); $80,000 for married taxpayers filing jointly; $40,000 for all other taxpayers) are adjusted for inflation and rounded down to the nearest $1,000 multiple. The AGI base amounts for 2008 and 2007 are:

 2008        2007
 ______________________________________________________________________________

 Married, filing jointly                             $96,000     $94,000
 All other taxpayers                                 $48,000     $47,000


Education Interest Expense


Up to $2,500 of interest expense paid on qualified education loans (as defined in section 221(d)(1)) may be deducted for AGI. The deduction is subject to a phaseout for taxpayers whose modified AGI (section 221(b)(2)(C)) exceeds specified targets. The interest expense deduction is reduced by applying the following formula:

 Modified AGI — AGI Base
 
Education Interest Expense  X  _____________________________

 
                               $15,000 ($30,000 for married,
 
                               filing jointly)

The AGI bases (section 221(b)(2)(B); $100,000 for married taxpayers filing jointly; $50,000 for all other taxpayers) are adjusted for inflation and rounded down to the nearest $5,000 multiple. The AGI base amounts for 2008 and 2007 are:

 2008        2007
 ______________________________________________________________________________

 Married, filing jointly                            $115,000    $110,000
 All other taxpayers                                 $55,000     $55,000


Qualified Transportation Fringe Benefits


To encourage the use of mass transit for commuting to and from work, some employee benefits, called qualified transportation fringe benefits, are excluded from income (section 132(f)(2) and (6)). Those benefits consist of expenses related to:

      1. Transportation from the employee's residence to work in a commuter highway vehicle;

      2. a transit pass; and

      3. qualified parking.


Categories 1 and 2, above, are combined and limited to a maximum of $100 per month. Category 3 has a separate limit of $175 per month. Both amounts are adjusted annually for inflation and rounded down to the nearest $5 multiple. The 2008 and 2007 limitations are:

 2008        2007
 ______________________________________________________________________________

 Commuter vehicle/transit pass                          $115        $110
 Qualified parking                                      $220        $215



Medical Savings Accounts


Medical savings accounts (Archer MSAs) were established by the Health Insurance Act of 1996 and are available to a limited number of eligible individuals. Currently, an individual is eligible for an Archer MSA if he is self-employed or elects to be covered under a high-deductible plan of a small employer (an employer who, on average, employs 50 or fewer workers). The definition of high-deductible plan includes amounts that are adjusted for inflation (section 220(c)(2)).

For 2008 a high-deductible plan is a health plan with the following deductibles and limitations on out-of-pocket expenses:


      1. Individual Coverage. An annual deductible of at least $1,950 and not more than $2,900 (up from $1,900 and $2,850 in 2007) and maximum out-of-pocket expenses for covered benefits not exceeding $3,850 (up from $3,750 in 2007).

      2. Family Coverage. An annual deductible of at least $3,850 and not more than $5,800 (up from $3,750 and $5,650 in 2007) and maximum out-of-pocket expenses for covered benefits not exceeding $7,050 (up from $6,900 in 2007).


Contribution Limitations
. The amount that can be contributed to an MSA is a function of the deductible of the high-deductible health plan. For individual coverage, the annual contribution limit is 65 percent of the deductible; for family coverage, contributions are limited to 75 percent of the deductible. As a result, the contribution ranges for 2008 and 2007 are as follows:

 2008                   2007
 ______________________________________________________________________________

 Individual coverage     $1,268 - $1,885        $1,235 - $1,853
 Family coverage         $2,888 - $4,350        $2,813 - $4,238


Health Savings Accounts


Health savings accounts can be established by individuals who are covered by a high-deductible health plan and not covered under any other health plan that is not a high-deductible health plan (section 223(c)). In late 2006, Congress passed the Tax Relief and Health Care Act of 2006 (P.L. 109-432). This act made several changes to the HSA provisions (including changing the inflation adjustment year-end from August 31 to March 31). Inflation-adjusted figures for 2008 were released by the IRS in May 2007 (Rev. Proc. 2007-36). In 2008 a high-deductible health plan is one with an annual deductible of at least $1,100 for individual coverage ($2,200 for family coverage) and maximum out-of-pocket expenses of $5,600 for individual coverage ($11,200 for family coverage). For 2007 those amounts are $1,100, $2,200, $5,500, and $11,000, respectively.

The maximum annual contribution to an HSA is the sum of the limits determined separately for each month, based on status, eligibility, and health plan coverage as of the first day of the month. For 2008 the maximum monthly contribution for eligible individuals with self-only coverage under a high-deductible health plan is one-twelfth of $2,900 (up from $2,850 in 2007). For eligible individuals with family coverage under a high-deductible health plan, the maximum monthly contribution is one-twelfth of $5,800 (up from $5,650 in 2007).


Long-Term Care Insurance Premiums


Long-term care insurance premiums that do not exceed specified dollar limits based on the insured's age qualify as a medical expense (section 213(d)(10)). The dollar limits are adjusted for inflation by comparing the medical care component of each August's CPI-U to the August 1996 CPI-U medical care component. Any increase is rounded to the nearest $10 multiple. After adjustment for inflation, the 2008 limitations will be as follows (2007 amounts for comparison):

 Insured's Age
 
Before Close of
 
Tax Year                   2008                2007
 ______________________________________________________________________________

  40 or less                $310                $290
  41 to 50                   580                 550
  51 to 60                 1,150               1,110
  61 to 70                 3,080               2,950
  More than 70             3,850               3,680

Long-Term Care Insurance Benefits


In general, long-term care insurance policies are treated the same as accident and health plans. When benefits are received from a long-term care insurance policy, whether funded by an employer or self-funded, an exclusion from gross income is provided (section 7702B). The exclusion is the greater of a daily rate (adjusted annually for inflation) or the actual cost of the care. In 2008 the daily exclusion rate will be $270 (up from $260 in 2007).

Traditional IRA Contribution Limits and Phaseouts

Any individual under age 70 1/2 can establish an IRA. The contribution ceiling is the lesser of (1) a statutory dollar limit ($5,000 in 2008, increased to $6,000 for those age 50 or older), or (2) 100 percent of the individual's compensation for that year. The tax treatment of a contribution will depend on whether the taxpayer is an active participant in a qualified retirement plan.

If the taxpayer is not an active participant, then the contribution is fully deductible. If the taxpayer is an active participant, then the IRA contribution deduction in 2008 is phased out beginning at a modified AGI of $53,000 for single taxpayers or heads of household (up from $52,000 in 2007), $85,000 for a married taxpayer filing a joint return (up from $83,000 in 2007), and $0 for a married taxpayer filing separately. The phaseout range is $20,000 for married taxpayers filing a joint return and $10,000 for all others. If the taxpayer is not an active participant but his spouse is an active participant, the contribution deduction in 2008 is phased out proportionally for modified AGI between $159,000 and $169,000 (up from between $156,000 and $166,000 in 2007).


Roth IRA Contribution Limits and Phaseouts


To encourage retirement savings, Congress introduced a provision that individuals may make nondeductible contributions to a Roth IRA (whose earnings and distributions are tax free). The contribution ceiling is the lesser of (1) a statutory dollar limit ($5,000 in 2008), or (2) 100 percent of the individual's compensation for that year. Roth IRA contributions are subject to income limits. In 2008 the maximum annual contribution to a Roth IRA is phased out beginning at modified AGI of $101,000 for single taxpayers or heads of households (up from $99,000 in 2007), $159,000 for married taxpayers filing a joint return (up from $156,000 in 2007), and $0 for a married taxpayer filing separately.

Section 179 Expensing

Section 179 allows taxpayers to expense business property that normally would be capitalized and depreciated. In May 2007, Congress passed the Small Business and Work Opportunity Tax Act of 2007, which was part of a larger appropriations bill (the U.S. Troop Readiness, Veterans' Care, Katrina Recovery, and Iraq Accountability Appropriations Act of 2007, signed into law May 25, 2007 (P.L. 110-28)). This act increased the maximum amount of modified accelerated cost recovery system property that can be expensed in 2007 to $125,000 and increased the acquisition cost ceiling (above which the expense amount is phased out) to $500,000. Both these amounts are adjusted for inflation beginning in 2008 (with the expense limit rounded to the nearest $1,000 multiple and the phaseout amount rounded to the nearest $10,000 multiple).

In 2008 the maximum section 179 expense election will be $128,000 (up from $125,000 in 2007), and this amount will be subject to a phaseout once property placed in service exceeds $510,000 (up from $500,000 in 2007). Absent a legislative change, the expense amount and acquisition cost ceiling will return to their pre-2003 amounts ($25,000 and $200,000, respectively) in 2011.


Five-Year Summary of Key Information


Table 3 presents a five-year summary of key inflation-adjusted information (tax rate schedules, standard deduction amounts, exemption amounts, and related AGI phaseout thresholds; and the AGI phaseout thresholds related to the overall limitation on itemized deductions).

Conclusion

The IRC includes several provisions subject to annual inflation adjustments. Identifying some of those provisions and communicating the adjusted amounts hopefully will assist taxpayers and tax practitioners in the tax planning process.

 ______________________________________________________________________________
                                   
Table 3
 
                              Tax Rate Schedules

 
   Indicated Rate Applies to Taxable Income in Excess of Specified Amounts
 _____________________________________________________________________________

                                     
Single

 
Year          15%          25%          28%          33%           35%
 ______________________________________________________________________________

 2008          $8,025       $32,550      $78,850      $164,550      $357,700
 2007          $7,825       $31,850      $77,100      $160,850      $349,700
 2006          $7,550       $30,650      $74,200      $154,800      $336,550
 2005          $7,300       $29,700      $71,950      $150,150      $326,450
 2004          $7,150       $29,050      $70,350      $146,750      $319,100

                               
Head of Household

 
Year          15%          25%          28%          33%           35%
 ______________________________________________________________________________

 2008          $11,450      $43,650      $112,650     $182,400      $357,700
 2007          $11,200      $42,650      $110,100     $178,350      $349,700
 2006          $10,750      $41,050      $106,000     $171,650      $336,550
 2005          $10,450      $39,800      $102,800     $166,450      $326,450
 2004          $10,200      $38,900      $100,500     $162,700      $319,100

                           
Married, Filing Jointly

 
Year          15%          25%          28%           33%          35%
 ______________________________________________________________________________

 2008          $16,050      $65,100      $131,450      $200,300     $357,700
 2007          $15,650      $63,700      $128,500      $195,850     $349,700
 2006          $15,100      $61,300      $123,700      $188,450     $336,550
 2005          $14,600      $59,400      $119,950      $182,800     $326,450
 2004          $14,300      $58,100      $117,250      $178,650     $319,100

                           
Married, Filing Separately

 
Year          15%          25%          28%           33%          35%
 ______________________________________________________________________________

 2008          $8,025       $32,550      $65,725      $100,150      $178,850
 2007          $7,825       $31,850      $64,250       $97,925      $174,850
 2006          $7,550       $30,650      $61,850       $94,225      $168,275
 2005          $7,300       $29,700      $59,975       $91,400      $163,225
 2004          $7,150       $29,050      $58,625       $89,325      $159,550

 
Standard Deduction Amounts

 
                                                    Additional Standard
 
              Basic Standard Deduction          Deduction (Elderly, Blind)
 ______________________________________________________________________________
               
Head of     Married,  Married,
 
Year  Single  Household   Jointly   Separately     Married      Unmarried
 ______________________________________________________________________________

 2008  $5,450     $8,000   $10,900     $5,450        $1,050        $1,350
 2007  $5,350     $7,850   $10,700     $5,350        $1,050        $1,300
 2006  $5,150     $7,550   $10,300     $5,150        $1,000        $1,250
 2005  $5,000     $7,300   $10,000     $5,000        $1,000        $1,250
 2004  $4,850     $7,150    $9,700     $4,850          $950        $1,200

 
Exemption Amount and Related AGI Phaseout Thresholds

                                 
Exemption Phaseout Threshold Amounts
                         _____________________________________________________
           
Exemption                  Head of          Married,     Married,
 
Year      Amount        Single       Household        Jointly      Separately
 ______________________________________________________________________________

 2008      $3,500        $159,950     $199,950         $239,950     $119,975
 2007      $3,400        $156,400     $195,500         $234,600     $117,300
 2006      $3,300        $150,500     $188,150         $225,750     $112,875
 2005      $3,200        $145,950     $182,450         $218,950     $109,475
 2004      $3,100        $142,700     $178,350         $214,050     $107,025

 
Overall Limitation on Itemized Deduction (AGI Phaseout Thresholds)

 
Year               Married, Separately                 All Other Taxpayers
 ______________________________________________________________________________

 2008                     $79,975                             $159,950
 2007                     $78,200                             $156,400
 2006                     $75,250                             $150,500
 2005                     $72,975                             $145,950
 2004                     $71,350                             $142,700




James C. Young is the Crowe Chizek Professor of Accountancy in the Department of Accountancy at Northern Illinois University in DeKalb, Ill.


About Tax Analysts

Tax Analysts is an influential provider of tax news and analysis for the global community. Over 150,000 tax professionals in law and accounting firms, corporations, and government agencies rely on Tax Analysts' federal, state, and international content daily. Key products include Tax Notes, Tax Notes Today, State Tax Notes, State Tax Today, Tax Notes International, and Worldwide Tax Daily. Founded in 1970 as a nonprofit organization, Tax Analysts has the industry's largest tax-dedicated correspondent staff, with more than 250 domestic and international correspondents. For more information, visit our home page.

For reprint permission or other information, contact communications@tax.org