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Inflation Adjustments Affecting Individual Taxpayers in 2008

by 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.

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:

2. The greater of:

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:

2. The greater of:

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: Thegreater 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:

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:

Individual Coverage

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.

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