Michael Henaghan, Managing Editor at Wolters Kluwer, breaks down the projected 2027 federal tax brackets—how they're calculated, why "bracket creep" quietly pushes taxpayers higher even when real income hasn't grown, and what's changing with 2027 retirement contribution limits (including the 401(k) jump to $25,500).
Well, Michael, it's so great to see you. Thanks for joining us this morning.
Thanks for having me. I'm happy to be here.
Yeah, really excited and look, taxes isn't a a fun topic for anyone, especially when it rolls around to April 15th, but you and the team have done a tremendous job. Uh and I think it's important that we understand kind of what's going on with taxes for 2027. So you and the team have done a great job in terms trying to figure out some of the tax brackets. Give us the uh before we kind of get into the meat and the details, we can talk about some of the retirement uh numbers, etc. Give us the the lay of the land, uh the process you use to calculate how you figure things out to the extent you can.
Sure. Um, so it's, you know, for someone like me, it's pretty interesting, right? It's it's a lot of fun. I it's a it's a fun little spreadsheet that we work with. Um, you know, it's it's not a huge mystery, right? Like it's all built into the tax code how it all works.
Um, basically what it comes down to is, you know, the internal revenue code determines these base amount for all these amounts, right? And it's there's over 100 inflation adjusted amounts that come out of the IRS every year. Um, you know, they set a base amount in the code and they set a base year, right? And then we go in and the way it works is you take a CPI rate, right? For a 12 month window. And you compare it to the CPI rate for the 12 month window of the base year and then from there on, it's just math, right? You divide the new CPI rate by the base year CPI rate, you multiply it by the base amount. There's a little bit of rounding that goes on on to it and then, you know, boom, you get the new number, right? It's a little bit more complicated than that. I might be over simplifying it, but what it comes down to is just, you know, plain old ninth grade math.
Yeah, uh and thank you for that and I I don't think you're, you know, I mean, I think you guys do a tremendous amount of work to do it. So it's probably not simple so that I can do it on a calculator. But be that as it may, um, I want to get into some of the tax code changes in a second. I'm not gonna ask you specific details, but what can you tell us about these these new tax brackets for 27? What should what should um tax filers be aware of? Because they should probably, well,
what should they be aware of? Then we can talk about what maybe they should do. So what should they be aware of when when you take a look at these new tax brackets?
Well, you know, the reason for making these new tax brackets is to avoid something that's called bracket creep, right? So as a very simple explanation of what that means and with numbers, I'm basically going to be making up is, so let's say that you are and married person, a married couple that makes $120,000 a year, right? That puts you in the 22% tax bracket. Now, what the common misconception about way the way tax brackets work is if, you know, your mind says I'm in the 22% tax bracket, that means if my taxable income is 120,000, I paid 22% of that to Uncle Sam, right? That's not how it works, right? It's a progressive tax system. So the first 20,000 you make is taxed at 10%. then from 20,000 to 100,000, it's taxed at 12%, I think. And then the amount over 100,000 is taxed at 22%, right?
What happens with bracket creep is if you don't adjust those brackets every year, the more money you make as a result of a cost of living increase, means that you're paying more in taxes, right? So like if you went from 120 to 125, now you have more income that's in that 22% tax bracket. If you got that increase because of a cost of living increase, you know, milk is more, gas is more, eggs is more, you're not economically making any more money. But if without the bracket adjustments, now you're paying more taxes on what is economically the same amount of income, right? So, um what we see from the tax brackets is really kind of a reflection of what you're seeing in the world, right? So, you know, inflation is higher than anyone would like. Like inflation is a naturally occurring thing, right? You know, a little bit of inflation is is a good thing. But when inflation is high, like we see that reflected in the tax brackets, we see it reflected in the standard deduction. We see it reflected all throughout, right? So I think the bottom line is what we're seeing now is inflation is high and that is reflected generally in in the tax code as well. So.
Well, hey, look, I mean, this is the reality we live in it and and unfortunately there are some challenges with affordability that we're all feeling and and that's probably a discussion for a different day. Let me ask you, um, so these are 2027 tax brackets. So that I'm assuming this would apply, correct me if I'm wrong, to income earned from January 1st, 2027 to December 31st, 2027. Am I correct in that assumption?
That is absolutely correct. Yes.
Okay. And so with this information coming out, I'm thinking about Americans out there, what what should they be thinking about? Should they be knowing that these tax brackets are going to change, they're armed with its information, they they may be working full-time jobs, many Americans are, should they be thinking about possibly and we don't want to give tax advice here, but should they be thinking about or re-evaluating their payroll deduction, the W4, all the things that they have filled out in the past. So should they take a look at those things with a tax advisor?
Um, you know, that's always a good advice, right? That's always a good thing to look at. You always want to, especially at the beginning of the year, you want to take a look at your withholding, make sure that you know, everything is is lining up right. But you know, the reality is you're gonna make what you're going to make, right? So I mean, you know, you know, for people who can defer income, like that's generally good advice. I know we're not giving tax advice. But, you know, income deferral is almost always a good thing, right? And but, um, you know, what it comes, but so the tax brackets aren't necessarily there's not a lot of uh there's not a lot of juice to squeeze out of that, right? You're going to make what you're gonna make, you're gonna pay what you're gonna pay, right?
What it comes down to is things like, you know, there are there are business deductions that are available to businesses, right? Like you know, larger businesses may, you know, the 179 deduction is an example, right? That is just for inflation too, right? Um, for individual taxpayers, a lot of that comes down to like things like retirement decisions, right? Like, you know, we can project out what like the IRA contribution limit is going to be for 2027, right? We project out what the um 401K contribution limit is going to be for 2027, right? And you know, eventually the IRS is going to come up out with this information too, right? But the the value of projecting it is, you know, you know, people get that information sooner, right? So you can kind of make those decisions ahead of time. And for, you know, a practitioner, right? Like which, you know, is who we serve, like they have that information and they can work with their clients earlier in the year to kind of set the get the groundwork running on those kind of decisions late in 2026. So, you know, maybe you could decide, you know, whether you're going to, you know, max out your IRA contribution this year or max it out next year, right? If you have a limited amount of money, you know, you have a little bit more wiggle room next year because that contribution limit is higher.
Well, I like that you bring up some of the deductions, um and and can we talk a few minutes about some of the benefits, the employee benefits, you mentioned IRAs, maybe the 401K, 403B, 457B limits, are those limits projected? I I would assume so, but the are they projected to go up significantly, uh maybe uh incrementally, what what what is the read there?
So that's an interesting foible of inflation adjustments, right? Because, you know, and it's not like in your head, right? reading the paper like inflation is 3 and a half percent. That means these things are going to go up by three and a half%, right? Um, because of the intricacies of how these things work and because of rounding, it doesn't always work out that in that linear of a fashion, right? So for example, so the 401K contribution, the limit the limit for 2026 was 24,500, right? We're projecting that that limit's going to go up to 25,500, right? That's a pretty big increase, right? That's
Yes. Yeah, it is.
That's more than a like if inflation is 3%, I believe that's more than a 3% increase, right? That all comes down to rounding, right? So because of the way the rounding works like it runs rounds down to the next lowest 500. So if you were just under the rounding cap. So if it was 24,500 last year, the unrounded amount might have been 24,999, right? But that rounded down to 24.5. Now with the adjustment, it goes up, say it goes up to 25,501, right? That works out to a $1,000 increase in the cap, but the actual math only made for like a $502 increase, right? You compare that to the IRA contributions limit, right, which last year was 7,500. We are projecting that's going to stay 7,500 next year, right? So it's a smaller number, so the increase has a little bit less of effect, but what it comes down to is weirdness with the way the rounding works, right? So it's always a little frustrating because like we'll project these numbers and we publish these numbers, right? And then we get questions like, well, inflation's five and a half percent or whatever it was, you know, a few years ago. This isn't reflected here. what it comes down to is rounding. So, um, it's not always an across the board increase of like, you know, whatever inflation is, right? Like it it it goes in little bits and little bits. So.
Well, that's fair. I mean, I think, look, it's good enough for, we used to say when I was working as as a cabinet maker, it's good enough for government work, meaning it's good enough, it's good enough for the information you need for the processing for the practitioners and then you come back. Hey, look, even the government refines its its labor numbers over a period of time, right? Don't they every quarter look back and say, hey, the the job market was this and we said it was that. So we have to give ourselves a little bit of grace. Let me um, let me end on this if I may and then, you know, maybe bring you back at another date as we maybe close out the year. Um, when does the Internal Revenue service? So these are projections, clearly the IRS has the final say, I would imagine, when do, when do the, when do they weigh in and then I would assume you guys make some adjustments along the way as well.
Yeah, so we're expecting those numbers to be released by the IRS any day now. I've been paying attention this morning, they haven't come yet. Um, you know, so there's two large batches of numbers that come out and they're based on different calculations. Um, the bulk of them are the ones that include the tax bracket, standard deduction, those kind of things. Those we've seen as early as October 9th, we've seen them as late as November, like the second week of November, right? Um, the retirement ones are based on a different batch of numbers. It's an extra month of CPI that gets included. Um, and again, we've seen those anywhere from mid October to mid November, right? But the IRS has all the data they need. It's just a matter of them doing whatever it is they do.
Yeah. Well, I'm sure they're pretty busy doing their audits and all the other and we just had the October 15th deadline, right? So I I have to think that they're pretty busy. Michael, great conversation, really important information. I think a lot of people maybe aren't aware. I wasn't certainly aware how these brackets get adjusted. Thank you so much for joining us and we look forward to having you back on the program again very soon, sir.
I'd be happy to be back, so. It's great being here. Thank you.
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