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What Exactly are "Taxable Income" and "Indexing"?

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In the second part of his series that answers questions from best-selling authors, Julian Block reviews a variety of topics, including explaining exactly what counts as taxable income and what the IRS means by the term "indexing" so your 2022 tax planning goes smoothly.

Jun 3rd 2021
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Just joining us? Go back to part one, where I answer a fascinating query from Patrick on whether there is a right time to donate for tax purposes.

He’s an easily irritated individual, and an unusually self-enamored author of best-sellers. Patrick maintains that there can be no two opinions about whether he’ll wind up as the recipient of a seven-figure-payment from the library or university that purchases his voluminous personal papers.

And just what does his cache contain? Patrick says it has original manuscripts for his books and articles, as well as exchanges of correspondence with lots of boldface names and A-listers.

Patrick threw in a mention of his plans to meet with Melania, his tax adviser, someone, he says, who knows her way around the Internal Revenue Code.

I told him to meet her ASAP. I’ll spell out why he should move expeditiously.

Some other things that I’ll discuss: the seven graduated brackets for ordinary income from sources like salaries and other kinds of compensation. 2021’s brackets ascend in stages––10, 12, 22 (nearly double the preceding 12), 24, 32 (a whopping one-third higher than the preceding 24), 35 and top out at 37 percent.

And I’ll go into more detail about: the top bracket and who’s subject to it; and deconstruct terms like “taxable income” and “indexing.”

Patrick, back to meeting Melania. For openers, get her recommendation on when to receive everything from the buyer. In 2021 or in 2022? Or in installments over, say, 2021, 2022 and 2023?

Oops, hold off on immediately asking her about when to receive payment; instead, ask that she schedule the meeting ASAP. Here’s why it’s vital that you move quickly.

What should be at the top of the agenda is a new concern introduced by a new president, Joseph Robinette Biden Jr. He wants to raise revenue and close the tax gap.  (In case you didn’t know, Robinette is the maiden name of the 46th president’s paternal grandmother.)

Just how adversely, Patrick, will you be affected in the event that Mr. Biden persuades the gang of 535– 539 if the District of Columbia becomes the 49th state and entitled to two Senate seats and one House seat, just like Wyoming– that they should increase the tax rates for affluent individuals who are recipients of ordinary income from sources like salaries?

Which filers receive ordinary income? Patrick, no surprises here.

They’re the ones who submit 1040 forms that report income from sources like these: salaries and other kinds of employee compensation, such as severance arrangements, net earnings from self-employment ventures; pensions; funds they withdraw from IRAs, 401(k)s and other kinds of tax-deferred retirement accounts; and Social Security benefits.

By the way, Patrick, I thought to be preemptive and resolve any doubts you might have about whether the list of ordinary-income recipients includes or excludes authors, whether based in Portland, Oregon, or elsewhere, who receive seven-figure payments for personal papers that include original manuscripts and historic exchanges of correspondence with boldface names and A-listers. It includes authors.

Indexing. Congress told the IRS to index the seven brackets, meaning the agency adjusts them annually to reflect inflation.

Ditto for the standard deduction amounts that are available to filers who decide not to use Form 1040’s Schedule A to itemize their outlays for things like: medical expenses (deductible only to the extent that they exceed 7.5 percent of adjusted gross income); state and local income and property taxes (capped at $10,000 by the Tax Cuts and Jobs Act); interest payments for mortgages on personal residences (subject to limits); and charitable contributions (a recent law change allows nonitemizers to claim donations of as much as $300 for 2020 and $600 for 2021).

Indexing provides another benefit, because it mitigates “bracket creep,” a much-maligned phenomenon that bumps Patrick and other filers into higher brackets. This holds true even though their real incomes remain unchanged.

Dear Readers, stay with us for what’s ahead in parts three and four. They’ll clue Patrick in on how the IRS defines “taxable income” and help him to better understand 2021’s top bracket of 37 percent.

Also on the agenda: how an affluent author like Patrick will be adversely affected in the event the 46th president, Joseph Robinette Biden Jr., overcomes opposition in the Senate––by probably all Republicans and perhaps even some Democrats––and prevails on his proposal to return the top rate of 37 percent to the 39.6 percent that it was before Congress approved and the 45th president, Donald John Trump, signed the Tax Cuts and Job Act.

By the way, the wide-ranging overhaul of the Internal Revenue Code okayed by the former president in the closing days of 2017 turned out to be his most significant legislative accomplishment, say his supporters, or, his sole accomplishment, say his detractors.

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