Inflation and taxes: How rising prices can affect your tax bill

INFLATION DOESN’T JUST AFFECT what you pay at the store and increase costs in important areas like healthcare. It can also reduce the purchasing power of your savings and shape how much you owe in taxes. Each year, the IRS adjusts key thresholds to account for rising prices. Understanding how these factors interact can help you make more informed tax decisions. Below are some ways inflation can affect your tax picture and potential solutions that may help minimize your tax bill.

How inflation affects your taxes

Inflation can impact your tax situation in several ways:

• The IRS adjusts tax brackets, deductions and contribution limits annually
• Salary increases intended to offset inflation may push you into a higher tax bracket
• Rising healthcare costs may outpace inflation, reducing the value of a tax-advantaged health savings account (HSA)
   

Because of these competing forces, your tax bill could go up or down in periods of higher inflation.

What to do: Review your tax strategy regularly with a tax advisor to understand how inflation is affecting your overall tax picture.

IRS inflation adjustments may lower your tax bill

The IRS typically updates tax provisions each year to reflect inflation. These adjustments often affect:

• Federal income tax brackets
• Capital gains tax thresholds
• Standard deductions
• Contribution limits for retirement plans, such as IRAs and 401(k)s
• HSA contribution limits
   

What this means: You may be able to earn more income without moving into a higher tax bracket, potentially lowering your effective tax rate. While these adjustments apply to your federal income taxes, many states don’t adjust tax brackets, standard deductions or personal exemptions for inflation. Ask your tax advisor about your state and local tax provisions.

What is not adjusted for inflation

Not all tax rules change with inflation. Over time, these fixed thresholds can increase your tax burden:

• 3.8% net investment income surtax thresholds
• 0.9% Medicare surcharge on wages over $250,000 for married couples ($200,000 for single taxpayers)
• Social Security taxation thresholds
• Capital gains exclusion limits on home sales of a primary residence — $500,000 exclusion for married couples filing jointly, $250,000 for single individuals
   

Strategy to consider: In years with larger inflation adjustments, you may have more flexibility to realize more income. For example:

• Converting a traditional IRA to a Roth IRA may not push you into a higher tax bracket if thresholds increase
• You can potentially time your income strategically, taking it when you’re in a lower tax bracket instead of waiting and possibly paying more later

Inflation could prompt a Social Security increase

The good: Social Security benefits are adjusted for inflation through cost-of-living adjustments (COLA), helping offset rising costs. These adjustments are based on inflation data from the July-through-September period of the prior year and may not fully reflect current cost pressures. Although recent cost-of-living increases reflect slower price increases overall between 2023 and 2025, some parts of the economy, such as housing, experienced higher inflation than others. And the annual inflation rate was 4.2% for the 12 months ending May 2026, up from 3.8%.¹

Recent COLA increases to Social Security benefits due to inflation:

• 2026: 2.8%
• 2025: 2.5%
• 2024: 3.2%
   

The bad: Higher benefits can increase your tax exposure.

• A larger portion of your Social Security benefits may become taxable
• Income thresholds that determine taxation of benefits are not adjusted for inflation
• If you’re still working, more of your wages may be subject to Social Security tax. The wage cap increased from $176,100 to $184,500 in 2026, exposing an additional $8,400 in income to the 6.2% payroll tax
   

Strategy to consider: Tax-loss harvesting may help offset increased taxable income: You can use investment losses to offset capital gains and up to $3,000 of ordinary income.

Higher wages can offset inflation but increase your tax liability

The good: When inflation outpaces wage growth, employees experience a reduction in purchasing power, which can put pressure on household budgets. Some employers raise wages to help offset inflation, which can help maintain purchasing power and employee satisfaction.

The bad: Higher income can trigger additional taxes by pushing you into a higher tax bracket and reducing or phasing out certain tax credits (such as child tax credits and education credits).

Strategy to consider: If your income rises, consider increasing contributions to tax-advantaged accounts:

• 401(k) or IRA contributions can reduce taxable income
• HSA contributions allow for tax deductible contributions if you have a high-deductible health insurance plan, and tax-free withdrawals for qualified healthcare expenses
• Contribution limits often increase with inflation, allowing you to save more

Even after you consider the factors above, there may still be other ways to potentially reduce your tax liability. Keep in mind that taxes can be complicated, so it’s a good idea to talk to a tax advisor before making any decisions.

Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.

¹U.S. Bureau of Labor Statistics, “Consumer prices up 4.2 percent over the year ended May 2026,” June 17, 2026.