Just as inflation and cost of living varies from year to year, many of the figures on your tax forms change annually. The good news is that the cost of living adjustment for 2012 will be noticeably larger than it has in past years. You will see the effect on your tax return in the form of larger exemptions for yourself and your dependents, a larger standard deduction, and a more forgiving tax bracket. Note that these are for the tax return you’ll file in the spring of 2013. 

First off, you’ll notice that the exemption for yourself, your spouse and your dependents is increased from $3,700 to $3,800. Additionally, the standard deductions are going up.  If you itemize on your taxes (meaning that you take deductions for items such as medical expenses, charitable donations and real estate tax) this will not affect you.  For those who take the standard deduction (and many people do) the amounts will be as follows:  $5,950 for singles and married filing separate; $8,700 for heads of households and $11,900 for married filing jointly and surviving spouses.

The next notable change is the shift in tax brackets (see below). This basically means that portions of your income are taxed at different rates depending on where you fall on the scale. For example, if you’re married filing jointly and your taxable income is $65,000, the first $17,400 is taxed at 10% and the rest is taxed at 15%. Essentially, the “steps” on this income ladder are all getting a little higher in 2012, which means that more of your income will be taxed at a lower rate. The higher your taxable income, the greater your overall savings will be.

Several other deductions and exclusion amounts are changing as well. The estate tax exclusion is increasing from $5 million to $5.12 million. The maximum foreign earned income deduction will increase from $92,900 to $95,100. If these do not apply to you, the next one might:  the medical savings account deductions will all rise, as shown in the chart below:

For some items, the actual amount of the credit or deduction will stay the same, but the phase-out threshold will increase. Many tax benefits are phased out at higher income levels; they gradually decrease until they are phased out completely. The threshold for the student loan interest deduction for joint taxpayers will rise from a modified adjusted gross income (MAGI) of $120,000 to $125,000. Note that this is only for joint filers; the threshold for singles will not change. The lifetime learning credit (an education credit for college students in their fifth year or later) will see a similar change but for singles as well as joint taxpayers. The phase-out for singles will be set at MAGI $52,000 (up from $51,000), and for joint filers it will be $104,000 (up from $102,000).

Other tax thresholds that are set to increase are the “nanny tax” and the wage base for Social Security taxes.  The “nanny tax” is a tax on wages paid by individuals for domestic services in their homes.  There is a certain base amount that is not considered FICA wages (subject to payroll taxes).  This threshold amount will increase in 2012 from $1,700 to $1,800.  Regarding Social Security tax, the wage base is the maximum amount of a person’s income that is subject to the tax.  Due to inflation, in 2012 it will go from $106,800 to $110,100.

Now that you’re up to speed on the tax code, you can go back to planning that Thanksgiving dinner.

Sources:
IRS Inflation Changes May Trim Your 2012 Tax Bill,” Oct 20, 2011.
RIA Newsstand. Oct 20, 2011, Based on Federal Tax Updates on RIA Checkpoint News Tab.
In 2012, Many Tax Benefits Increase Due to Inflation Adjustments,” Oct 20, 2011.
Revenue Procedure 2011-52.  
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