Inflation could lead to modest tax cut in 2012

— -- Come 2012, there's a good chance you'll get a modest tax cut. Please don't call your congressional representative to applaud or condemn this development. Instead, credit the price of milk, or gas.

Since the 1980s, the IRS has adjusted tax brackets annually to prevent "bracket creep," which occurs when inflation pushes taxpayers into higher tax brackets, even though their purchasing power hasn't changed. In the past two years, low inflation has led to microscopic adjustments. The IRS applied a 1.4% inflation rate for 2011 tax brackets and a 0.18% inflation factor for 2010.

As anyone who shops or drives can tell you, inflation has increased this year. The formula the IRS uses is expected to be based on a 3.8% annual inflation rate, according to tax publisher CCH. Here's how that will affect taxpayers in 2012:

•More income will be taxed at lower rates. Under our tax system, you pay taxes on your ordinary income at graduated rates. For example, if you're single and earn $36,000 a year, you pay 10% on a portion of your income, 15% on another portion and 25% on the third portion. The top rate you pay — in this case, 25% — is known as your marginal rate. When tax brackets are indexed to inflation, more of your income is taxed at a lower rate: for example, at 15% instead of 25%.

All things being equal, a married couple with taxable income of $100,000 should expect to pay $190 less in income taxes in 2012 than they'll owe in 2011, according to CCH.

The savings will be even more dramatic for taxpayers in the 35% bracket, CCH says. The 35% bracket is projected to increase from $379,150 to $388,350. In addition, taxpayers in this group will see more of their income taxed at the lower incremental rates. A married couple with taxable income of $450,000 in 2012 would pay $732 less in taxes than they did in 2011, CCH says.

•Your standard deduction will increase. CCH estimates that the standard deduction for married couples who file jointly will be $11,900 in 2012, an increase of $300 from 2011. For singles, the standard deduction will increase to $5,950 from $5,800.

A higher standard deduction lowers your taxable income. More than two-thirds of taxpayers claim the standard deduction because they don't have enough deductions to justify itemizing.

•Your personal exemption will increase. In 2012, the personal exemption taxpayers claim is expected to be $3,800, an increase of $100 from 2011, CCH says.

•More taxpayers will qualify for tax breaks. The inflation adjustment will increase income limits for a number of popular tax incentives, such as tax credits for education and deductible contributions to individual retirement accounts, says George Jones, senior federal tax analyst for CCH.

•The estate-tax exemption will increase. The expiration of the estate tax in 2010 inspired a lot of dark humor about the advantages of dispatching wealthy relatives before the tax returned in 2011. As a result of a compromise struck that year, though, eager heirs will want to keep Grandma comfortable until 2012.

Under a compromise reached in Congress at the end of 2010, the estate-tax exemption was set at $5 million for 2011 and 2012. The compromise also required an inflation adjustment for 2012. CCH projects that next year, $5.12 million will be exempt from the current 35% estate tax.

The compromise expires at the end of 2012. Given the level of political gridlock, Jones says, "no one really knows what will take place" in 2013.

Sandra Block covers personal finance for USA TODAY. Her Your Money column appears Tuesdays. E-mail her at: sblock@usatoday.com. Follow on Twitter: www.twitter.com/sandyblock. See an index of Block's columns.