Higher Inflation Might Reduce Some People’s Tax Bills
The U.S. Bureau of Labor Statistics’ most recent data confirms what has already become a recurrent theme for 2022. Sometimes the fight against inflation is just a plodding process.
And while chronically high inflation is not good news, a set of yearly adjustments based on an inflation index can ease the burden on taxes.
Preventing Bracket Creep
The IRS typically announces a wide range of revisions to various tax regulations, including tax brackets, basic deductions, and specific tax credits, in early November.
The IRS wants to stop bracket creep. Therefore, these adjustments are based on the Chained Consumer Price Index for All Urban Consumers. In other words, the IRS can prevent inflation from eroding the initial basis for a tax credit. Or threshold thanks to these yearly adjustments.
Consider a married couple filing jointly with an $80,000 taxable income as an example. This would place the taxpayers in the 12% tax rate starting in 2022. If there were no changes to the tax brackets in 2023 and that couple received a $10,000 pay increase as a result of a cost-of-living adjustment. Some of their earnings would be shifted into the next bracket and subject to a 22% tax rate.
What Modifications Are Anticipated for 2023
The unprecedented rate of inflation this year has had an impact on pretty much everything. Including predictions of the adjustments, the IRS will make this fall. In comparison to a 3% increase in tax provisions last year, several tax professionals predict an approximately 7% increase this year.
Substantial Changes to Tax Brackets
The predictions’ major increase to income thresholds for all filing statuses in 2023 is perhaps their most notable callout. For married couples filing jointly, the top income limit for the 12% tax bracket might increase from $83,550 in 2022 to $89,450 in 2023. This could prevent some people from falling into a higher tax rate (and potentially a higher bill).
A larger-than-usual increase in the standard deduction, a fixed amount that taxpayers can utilize to lower their taxable income, is also anticipated. Married couples filing jointly in 2023 may be able to claim up to $27,700, an increase from $25,900 in 2022.
Additional Tax Credits
We might also see changes to some tax credits, which might result in extra savings for some taxpayers. The popular child tax credit’s refundable portion may increase from $1,500 to $1,600. While the earned income tax credit, which benefits lower-income taxpayers, may increase from a maximum of $6,935 to $7,430 for families with three or more children.
Increased Limits on Savings Contributions
In some cases, increasing a taxpayer’s contributions to certain tax-advantaged accounts might reduce their taxable income.
You might be able to make an IRA contribution of up to $6,500 in 2023, up $500 from 2022. Additionally, people over 50 typically receive a catch-up contribution that allows them to contribute an additional $1,000. Predictions are that contribution caps for 401(k)s and other employer-sponsored retirement accounts would see equally large hikes. In the upcoming weeks, the IRS is anticipated to make the official figures public.
People who have health savings accounts, or HSAs, may be able to contribute up to $3,850 for individuals. Or up to $7,750 for a family in 2023. HSAs allow you to contribute a specific amount of your salary pretax for medical bills.
There Might Be No Assurance
There is no assurance that your bills would be reduced. Many things affect your overall tax liability. However, these changes will likely allow people to take a more generous standard deduction or put more money into accounts that could lower taxable income.
Additionally, several tax provisions do not undergo annual inflation adjustments. This applies to several tax incentives including the capital loss deduction. This enables investors with net losses to reduce their taxable income by a maximum of $3,000 per year, and the state and local tax deduction, which has a $10,000 limit until 2025.
The Bottom Line
Codification changes are intended to mitigate the effects of inflation; as a result, people whose earnings may not have kept pace with inflation may gain, and others who received cost-of-living raises may avoid moving into a higher tax bracket.
Contact a professional from Your Part Time Accountant and get help immediately!