One ripple effect of the high inflation eating into
Americans’ spending power may be lower tax bills.
Many workers will get bigger paychecks in January and be
able to stash more money in their retirement accounts when the Internal Revenue
Service makes its annual inflation adjustments to dozens of tax provisions.
Normally these are minimal modifications, but given August’s persistently high
inflation data, tax experts estimate a significant impact on 2023 taxes.
More of Americans’ income will be taxed at lower rates next
year, when the thresholds for income-tax brackets and the standard deduction
are raised, thanks to automatic inflation adjustments built into the tax code,
tax professionals say. A single taxpayer with $100,000 of adjusted gross income
in 2023, could see a tax savings of about $500 compared to someone with the
same income this year, according to Jim Young, an accounting professor at
Northern Illinois University.
Estate- and gift-tax thresholds are expected to go up, too,
allowing a couple to shelter nearly $2 million more from these taxes. And the
contribution limits will likely be raised for retirement plans, meaning more
tax-advantaged savings.
“Over the last decade, inflation has been moderate, so we
only saw minor increases in tax parameters each year,” said Kyle Pomerleau, a
federal tax policy expert at the American Enterprise Institute. “This year, we
will see a much larger adjustment as prices have risen much faster.”
These inflation adjustments can hardly be called a silver
lining, as Americans are paying more for everything from housing to food and
energy.
The IRS makes the adjustments based on formulas set out in
federal law that are somewhat different from headline inflation numbers. The
Labor Department on Tuesday reported its consumer-price index was 8.3% higher
in August than the same month a year ago.
The tax-provision adjustments are tied to an alternate
inflation measure called the chained consumer-price index, which takes into
account the substitutions shoppers make as costs rise. The average of the
chained CPI from September 2021 to August 2022 is used to calculate the 2023
adjustments, which the IRS will announce in October or November. These
ultimately affect tax returns for the 2023 tax year filed in early 2024.
“Adjusting tax-return data for inflation was a purposeful
decision by Congress intended to shield taxpayers from annual inflation,” said
Mr. Young. “This will hopefully help taxpayers cope with rising prices.” The
benefits of these changes could be offset by inflation in other ways. If your
wages have gone up, your total tax bill may not go down, Mr. Young said.
Here are the estimates, for the IRS adjustments, according
to the American Enterprise Institute:
The threshold for the top federal income-tax bracket in 2023
is expected to climb by nearly $50,000 next year for married couples, and that
37% rate will apply to income above $693,750. For individuals, that top tax
bracket will start at $578,125.
Those levels and the other tax-bracket break points will all
rise about 7% from tax year 2022, compared with about 3% last year, which was
the largest increase in four years. This year’s increase is the largest in the
past 35 years, said Mr. Young.
The expected increases in many of the tax-related provisions
will be smaller than the estimated 8.7% increase in Social Security monthly
benefits anticipated by the Senior Citizens League because the adjustments
follow different rules.
The Social Security wage base tax level is estimated to
increase 5.5% from $147,000 to $155,100 in 2023, according to the 2022 Social
Security Trustees Report.
The standard deduction for married couples is expected to be
$27,700 for 2023, up from $25,900 this year, and $13,850 for individuals, up
from $12,950. This is the amount those who don’t itemize deductions on their
returns can subtract from their total earnings subject to income taxes.
The federal estate-tax exclusion amount, what an individual
can shelter from estate taxes, is $12.06 million this year. It is expected to
increase to $12.92 million for 2023, meaning a married couple could shelter
nearly $26 million from estate tax with little planning.
The annual limit on tax-free gifts is expected to climb from
$16,000 this year to $17,000 for 2023. The taxpayers who benefit from this are
high-wealth individuals, said Mr. Young. They can give away more without
estate- or gift-tax consequences.
The maximum contribution amount for an individual retirement
account is expected to jump to $6,500 for 2023, up from $6,000, where it has
been stuck since 2019. The maximum contribution allowed for a healthcare
flexible spending account is expected to increase to $3,050 in 2023, up from
$2,850 this year.
The maximum contribution amount for a 401(k) or similar
workplace retirement plan is governed by yet another formula, using inflation
data through September. Actuaries at Milliman, a benefits firm, estimate that
the contribution limit will rise from $20,500 this year to $22,500 in 2023, and
the catch-up amount for workers aged 50-plus will rise from $6,500 to at least
$7,500.
The child tax credit is even more complicated. Under current
law, the total tax credit of $2,000 per child isn’t adjusted for inflation, Mr.
Pomerleau said. But the additional child tax credit that is refundable and
available even to taxpayers who have no tax liability, is adjusted for
inflation. It is expected to rise from $1,500 to $1,600 in 2023. The income
limits related to the CTC aren’t adjusted for inflation.
Click here for the
original article.