In a time of rising costs, the Internal Revenue Service just raised income-tax brackets for next year.
It might feel tough sometimes to link the IRS with the concept of good news, but the adjustments for 2023 income tax brackets, the widely-used standard deduction and roughly 60 other inflation-indexed tax provisions, might be one of those times.
How so? The large upward adjustments could create a chance to hold onto more cash when you file you 2024 tax return on next year’s income.
“‘From a strictly tax perspective, yes, they have some tax savings. The bad news is wages stayed stable when everything else increased.’”
The payout on the standard deduction is jumping 7% from 2022 to 2023, the IRS numbers show. The standard deduction becomes $27,700 for a married couple filing jointly, an $1,800 increase from this year’s payout. It will increase to $13,850 for individuals and for married couples filing separately, a $900 rise.
Likewise, the income ranges on the tax code’s seven marginal tax rates will jump 7% for tax year 2023. The adjustments are based on averages for one of the government’s inflation gauges.
Here’s how the new tax brackets will affect household income, according to Timothy Steffen, director of tax planning at Baird Private Wealth Management:
- “A married couple with taxable income of $200,000 in both 2022 and 2023 would see a reduction in their tax of nearly $900. A couple at $500,000 of income would see their tax bill fall by over $3,700.”
- “For single taxpayers at those same income levels, their tax bills would be reduced by roughly $1,400 and $1,900, respectively.”
- A married couple with no kids that made $150,000 this year and next year would pay $1,015 less on their 2023 federal income tax bill, Steffen’s estimates showed. A single filer with no kids making $150,000 this year and next year would face a tax liability that was $652 smaller, according estimates that, he noted, didn’t assume business or investment income or extra deductions beyond the standard deduction.
- A married couple without kids making $75,000 this year and next year would pay $245 less on their 2023 taxes, Steffen’s estimates’ showed. A single filer would save just over $500, the estimates said.
- “The larger standard deduction also means a bigger tax break, as more income is automatically exempt from tax. The flip side of this, though, is that it’s going to be harder to itemize your deductions in 2023. That means your tax payments, mortgage interest and charitable contributions are less likely to provide you a tax benefit next year.”
“Inflation adjustments to tax brackets mean that it will be harder for taxpayers to hit those higher brackets, and therefore will have more income taxed at lower rates next year,” he said.
Put another way, “the changes in tax brackets means that more income is taxed at lower rates or conversely, less income is taxes at higher rates,” said Andy Phillips, director of the Tax Institute at H&R Block HRB, +1.29%. “The more generous standard deduction serves to lower taxable income and, as a result, lower tax,” Phillips added.
But don’t get carried away by the tax code’s silver linings during four-decade high inflation rates, said tax attorney Adam Brewer. September’s yearly rate of inflation was 8.2%, government data showed.
The IRS adjustments are “good news for taxpayers. It’s just not enough good news, I would say. Anyone who saves money on this, you’ll get a bigger refund in 2024,” said Brewer, of AB Tax Law. But that’s cold comfort now, he added. “You can’t put a tax refund in February 2024 into the gas tank.”
The adjustments bring a lot of implications, but let’s start with some basics.
There is a chance for tax savings
The actual rates applied to income tax brackets stay at 10%, 12%, 22%, 24%, 32% and 35%. But the nominal dollar amounts attached to each bracket are increasing.
Now suppose household income stays the same in 2022 and 2023, even as the next highest income tax bracket is farther away.
Of course, it’s a hypothetical that might not fit entirely with the tight labor market. Many employers are cutting fatter paychecks to hold onto staff. But the tax question is where increased wages land in relation to the upward adjusted tax brackets.
“The idea here is not that people will pay less tax,” said Howard Gleckman, senior fellow at the Tax Policy Center. “The idea is to keep your tax liability relatively stable” and avoid what’s called “bracket creep” where inflation pushes someone into a bigger tax bill when they don’t have the spending power to afford it.
“Taxpayers whose income remained stable are going to pay less tax on the same income because of the graduated tax scale,” Brewer said. “From a strictly tax perspective, yes, they have some tax savings. The bad news is wages stayed stable when everything else increased.”
It could push even more people to use the standard deduction
Come tax time, people can choose between the standard deduction and itemized deductions. The latter includes write-offs like charitable contributions, state and local taxes, interest paid on mortgages and medical expenses.
It makes tax sense to itemize when the sum of the potential write-offs is larger than the potential standard deduction payout. Almost 14% of taxpayers itemized deductions in their 2019 tax returns and they were typically richer, according to a Tax Foundation analysis.
Speeding up expenses with a potential for an itemized deduction could be one strategy to reap the tax benefits now, he said. (The charitable contribution write-off for taxpayers who took the standard deduction expired at the end of last year.)
2023 retirement account contribution limits are a sizeable jump up
The tax year 2023 inflation adjustments announced Tuesday were one piece of the tax planning puzzle.
There’s also the question of how much the IRS is going to let savers sock away in retirement accounts like 401(k)s, IRAs and the income thresholds for possible deductions. This year, individuals can put up to $20,500 in their 401(k), an increase from $19,500. (Catch-up provisions let workers over age 50 put away another $6,500 for a total $27,000 this year.)
On Friday, the IRS released the 2023 contribution limits on 401(k)s, IRAs and other retirement savings accounts.
Ahead of the announcement, Steffen and Gleckman said the chances were good the increases would be sizeable, in light of the inflation adjustments to other provisions.
They were right. The IRS says people can put up to $22,5000 in 401(k) accounts next year and up to $6,500 in IRAs. Those are nearly 10% and 8% increases from the limits set for 2022.
It’s “important” but not “critical” to know future 401(k) and IRA contribution limits before the upcoming calendar year, Julie Virta, senior financial advisor at Vanguard Personal Advisor Services, said prior to Friday’s announcement about next year’s contribution limits. The bigger focus is ono pouring as much as possible into current contributions, she said.
“We typically tell clients to aim to save between 12%-15% of their salary via retirement savings vehicles,” said Virta. “Between now and year-end, 401(k) investors should evaluate where their account stands, and determine if they can increase contributions. For IRAs, investors have a bit more time in that their 2022 contribution deadline is April 15 of next year.”