Next Year's Tax Brackets Are Being Set by an Inflation Measure Most People Have Never Heard Of

Bloomberg Tax published its projections for the 2027 federal tax figures in September, applying a 3.2% inflation adjustment. On those numbers the standard deduction goes to $16,600 for a single filer and $33,200 for a married couple filing jointly, the 37% rate begins above $661,375 and $793,650 respectively, and the estate tax exemption reaches $15,480,000 per person.

These are projections. The Internal Revenue Service has not published the official figures, which normally arrive in the second half of October. They are usually very close, because the arithmetic is set by statute rather than by judgement.

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The index used is not the one in the headlines

Tax brackets are not adjusted by the consumer price index that gets reported each month. Since 2018 they have been indexed to the chained consumer price index for all urban consumers, which accounts for consumers substituting between goods when relative prices change. Because substitution reduces measured inflation, the chained index runs slightly below the headline measure, typically by a few tenths of a percentage point a year.

The consequence compounds quietly. Every year the brackets rise a little less than prices do, so a taxpayer whose income merely keeps pace with inflation drifts into a marginally higher effective rate. This is bracket creep, reintroduced in a milder form after decades in which indexation was supposed to have eliminated it.

There is a procedural wrinkle in this year's calculation worth noting. The adjustment uses the chained index from September of the prior year through August, and a lapse in federal appropriations meant the figure was computed from an eleven month average rather than the usual twelve. That is a small technical difference and it is the sort of thing that makes the official number land a hair away from the projection.

What actually changes in a household

Whitmore's Watchlist:
TFI (SPDR Nuveen Bloomberg Municipal Bond ETF): Tax exempt income, which becomes more valuable the higher the bracket.
SUB (iShares Short-Term National Muni Bond ETF): The same exemption with much less interest rate risk.
ITOT (iShares Core S&P Total U.S. Stock Market ETF): A broad, low turnover equity holding, where the tax efficiency comes from not trading.

A 3.2% adjustment moves real money for a small number of decisions and almost none for the rest.

The standard deduction is the one that touches nearly everybody, since the large majority of filers take it. A couple's deduction rising by about a thousand dollars is worth a few hundred in tax at a middle bracket.

The long term capital gains thresholds matter more than they look. On the projections, the 15% rate runs up to $563,200 for a single filer and $633,600 for a couple, and below those thresholds there is a band where long term gains are taxed at zero. For a retiree with modest ordinary income, realising gains deliberately up to that line each year is one of the few genuinely free decisions in the tax code, and the line moves every January.

The estate exemption at $15.48 million per person is relevant to very few households directly, but it also governs lifetime gifting, which reaches considerably more.

Why the bracket number is not the planning number

thresholds above, the income levels at which Medicare premium surcharges begin, the phase outs on credits and deductions, and the taxation of Social Security benefits.

Those thresholds do not all move together, and several are not indexed at all. The income levels that trigger Social Security benefit taxation have been fixed in nominal terms since the 1980s and 1990s, which is why an increasing share of retirees pays tax on benefits every year without any law changing.

So the practical reading of a bracket announcement is not what rate you pay. It is where next year's thresholds sit relative to the income you expect, and whether a decision that is discretionary as to timing, a Roth conversion, a gain realisation, a bonus deferral, lands on the better side of one of them.

That exercise is worth doing in November, when the official figures are out and there is still time to act before the year ends, rather than in April when nothing can be changed.

Whitmore's Take: Brackets indexed to a slower inflation measure mean a taxpayer standing still drifts upward a little each year. Worth checking the thresholds that actually govern your decisions rather than the rate on your top dollar.

Disclaimer
The content in this email does not constitute an offer or solicitation to buy or sell any financial instrument. All commentary is general in nature and is not directed at any individual investor.

Written by Daniel Whitmore
Millionaire Insiders