The Tax Consequences of Higher Inflation in 2005

January 22, 2006

The Bureau of Labor Statistics (BLS) released price level data last week showing that the Consumer Price Index for all urban consumers (CPI-U) grew in 2005 at the highest rate in five years, mostly the result of higher energy prices. From the Washington Post:

Record prices for gasoline and other fuels sent inflation rising in 2005 at the fastest pace in five years, and hopes for a slower increase this year could be dashed if energy costs keep surging.

Consumer prices rose by 3.4 percent in 2005 with 40 percent of the increase blamed on the biggest jump in energy costs since 1990. Energy was up 17.1 percent this past year, reflecting gasoline prices that for a time soared above $3 a gallon and crude oil prices that topped $70 per barrel. (Full Story)

The federal tax code has many components that are adjusted annually for this CPI-U inflation statistic, including tax rate brackets, the standard deduction, personal exemptions, most phase-out levels, and certain credits.

The adjustment based upon this inflation experienced in 2005 will go into effect for the current tax year (2006), and will be relevant for the filing season from Jan. – Apr. 2007.

But the number will be slightly greater than the 3.4 percent inflation experienced in calendar year 2005 because the IRS adjustment is calculated based upon a different time period: Sep. 2004 through Aug. 2005. (This is done in order to adequately and accurately prepare for the upcoming tax year.)

From Sep. 2004 through Aug. 2005, the inflation rate (based upon CPI-U) was actually 3.6 percent. It is higher than the calendar year 2005 number because September, October, November, and December 2005 experienced relatively low inflation, mostly due to falling energy prices in the final two months, while September, October, November, and December 2004 experienced higher inflation. (You can check out an easy-to-read data table on the monthly CPI-U levels by clicking here, dating back to 1947 courtesy of the Federal Reserve Bank of St. Louis.)

The Internal Revenue Bulletin (2005-47) published by the IRS in November details specifically the inflation adjustments that have gone into effect for the 2006 tax year.

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