7 minute read
Russia has invaded Ukraine, and that begs the question: what, if any, tax consequences might there be for Americans? To answer that, let’s first look at history to see what other incidents have made tax impacts.
While the United States is not yet involved in the Russian invasion of Ukraine in a military sense , the potential for the situation to escalate into war remains on the table. So, it’s prudent to look at how previous wars influenced US taxes.
This is just a brief overview, but it certainly points to a trend: war often brings higher taxes in order to fund war. If taxes aren’t raised, domestic spending cuts are on the table in order to shift funds into the war.
So far, the White House has given little indication of how it might plan to pay for potential war with Russia. Tax increases could be on the table, although it may be more likely Biden will want to just put it all on the national credit card — i.e., adding more to the national debt.
Increasing the national debt is not without its problems though. There have been ongoing political battles regarding raising the debt ceiling (the limit imposed by Congress on how much debt the federal government can owe), with the most recent round resulting in Democrats passing a bill in December of 2021. Historically, increases are less likely to happen under a Democratic president, but if raising taxes is taken off the table, it may be the best option.
What is already one of the biggest taxes in the US? It’s often referred to as the “hidden tax,” and it’s called inflation. When inflation runs hot, it causes a tax increase as tax brackets don’t adjust for changes in consumer purchasing power. This is also known as “bracket creep.”
When inflation happens, items such as energy, shelter, food and cars get more expensive. When money doesn’t go as far as it used to, it stretches the finances of citizens. As inflation increases, tax brackets lose value if they are not adjusted accordingly.
This drop in value can cause increased tax bills because it causes more of a person’s income to fall within a higher tax bracket — artificially due to inflation, not because they made real higher earnings.
As an example, a woman made $61,000 in taxable income a year ago, and this year she will make $65K. However, because of inflation, she is spending more of her income on basic needs. She doesn’t actually have an increase in real income because she has the same purchasing power. The $65K has around the same value today that the $61K had a year ago.
If her state’s income tax bracket isn’t inflation-indexed, she could be in a higher tax bracket. Practically speaking, she will owe more in taxes but her purchasing power is the same!
Historically during war, inflation has increased from the combination of increased debt obligations, higher taxes, increased demand for certain items, and shortages of basic or high demand goods. This, combined with bracket creep, can have a serious impact on spending power.
In the likelihood that war with Russia will cause more federal deficits and more inflation, the states that don’t prevent bracket creep by indexing for brackets are:
Citizens in these states might expect a higher “hidden tax” if war becomes a reality. Meanwhile, the following states help prevent bracket creep by indexing for brackets — and, therefore, citizens might see less of a “hidden tax” in these places:
Regardless of what transpires, inflation will likely remain a dominant issue this year. The higher the inflation rate, the more taxpayers will experience the “hidden tax” when they file their taxes in 2023.
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Sanctions on Russian oil and gas will mean higher energy prices the world over. Americans, therefore, can expect to pay higher prices at the pump. However, Democrats have recently been weighing suspending the federal gas excise tax to cut prices. This would be with a gas tax holiday to provide inflation relief.
It’s still too soon to tell if war in Ukraine would impact this proposal, but so far it has encountered resistance with Republicans who are skeptical that a gas tax holiday would actually provide relief in prices at the pump. The argument is that if a gas tax holiday were to provide lower costs to consumers, it would just result in a spike in demand during the period it would be in effect with rising prices in response.
Former President Obama was critical of gas tax holidays, calling them a short-term fix that wouldn’t solve the long-term problems of high oil prices or foreign oil dependency. In addition, if there is a gas tax holiday, there will be lost tax revenue unless some other source of tax revenue is made. Therefore, it seems unlikely a gas tax holiday will happen, especially if war happens with Russia.
As gas prices may further increase this year, keep in mind that taxpayers can potentially save money by taking advantage of tax strategies, such as mileage deductions. You’ll need to meet certain requirements and itemize your taxes in order to claim a deduction for miles driven. If you qualify to deduct mileage, the federal IRS mileage rate is a way for you to calculate how much you can reduce your taxable income. Currently, the mileage rate is 58.5 cents for business miles driven and 18 cents per mile driven for moving or medical purposes.
Your mileage tax deduction also depends on how you use your vehicle. If you’re a contractor or are self-employed, you could be able to deduct the cost of the use of your car for business purposes. Just keep in mind that commuting to work is generally not considered deductible mileage.
To help fight tax bracket creep; you can look for ways to reduce your AGI. Increasing your contributions to retirement plans and tax advantage medical plans in particular can reduce your AGI to lower your tax bill. And with medical plans, you aren’t taxed on the distributions if they are used for qualified medical expenses. For more tax savings opportunities, ask your accountant if they do any proactive tax planning using tools like Corve tax planning software.
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