The IRS said it is adjusting many of its rules to account for the impact of inflation, ranging from individual income tax brackets for 2023 to the standard deduction. The changes could mean tax savings for some taxpayers next year.
The higher limits are aimed at avoiding "bracket creep" due to inflation, which can push workers who received annual cost-of-living pay increases into higher tax brackets even though their standard of living hasn't changed.
The IRS makes such adjustments annually, butmeans that many of the changes are more significant than in a typical year. Americans are struggling with stubbornly high inflation, which is eating into their purchasing power as average wage gains lag the sharp rise in prices.
The higher provision thresholds could provide relief to some taxpayers who fall into lower tax brackets as a result, said Tim Steffen, director of tax planning with Baird, in an email. For instance, Steffen noted that a married couple earning $200,000 in both 2022 and 2023 would save $900 in taxes next year because more of their income would be taxed at a lower rate.
Here are the changes announced by the IRS on October 18, with the inflation-adjusted provisions taking effect for the 2023 tax year. Taxpayers will file their 2023 tax returns in early 2024.
The standard deduction is used by people who don't itemize their taxes, and it reduces the amount of income you must pay taxes on.
- For married couples filing jointly, the standard deduction will rise to $27,700, up from $25,900 in the current tax year. That's an increase of $1,800, or a 7% bump.
- For single taxpayers and married individuals filing separately, the standard deduction will rise to $13,850 in 2023 from $12,950 currently. That's an increase of about 6.9%.
- Heads of households will see their standard deduction in 2023 jump to $20,800 from $19,400 this year. That's an increase of 7.2%.
"The flip side of this, though, is that it's going to be harder to itemize your deductions in 2023," Steffen said. "That means your tax payments, mortgage interest and charitable contributions are less likely to provide you a tax benefit next year."
Most taxpayers take the standard deduction, especially after the 2017 Tax Cuts and Jobs Act enacted a more generous deduction. Only about 14% of taxpayers itemized their taxes after the passage of the tax overhaul, or a 17 percentage-point drop compared with prior to the law, according to the Tax Foundation.
The IRS is boosting tax brackets by about 7% for each type of tax filer, such as those filing separately or as married couples. The top marginal rate, or the highest tax rate based on income, remains 37% for individual single taxpayers with incomes above $578,125 or for married couples with income higher than $693,750.
The lowest rate remains 10%, which will impact individuals with incomes of $11,000 or less and married couples earning $22,000 or less. Below are charts with the new tax brackets.
Tax brackets show the percentage you'll pay in taxes on each portion of your income. A common misconception is that the highest rate is what you'll pay on all of your income, but that is incorrect.
Take a single taxpayer who earns $110,000. In 2023, she will take a standard deduction of $13,850, reducing her taxable income to $96,150. She'll pay:
- 10% tax on her first $11,000 of income, or $1,100 in taxes
- 12% tax on income from $11,000 to $44,735, or $4,048
- 22% tax on the portion of income from $44,735 up to $95,375, or $11,140
- 24% tax on the portion of her income from $95,374 to her limit of taxable income, $96,150, or $775
Together, she'll pay the IRS $17,063 in taxes, which gives her an effective tax rate of 17.7% on her taxable income.
Flexible spending accounts
Flexible spending accounts allow workers to put money, up to the limit allowed by the IRS, in an account that can be used to pay for medical expenses. Because the funds are taken from their accounts on a pre-tax basis, it offers tax savings for many workers.
The new IRS limit for FSA contributions for 2023 is $3,050, an increase of about 7% from the current tax year's threshold of $2,850.
Because employees set their FSA limits in the fall, ahead of the new calendar year, people will be using this new IRS threshold to decide on their contributions within the next few weeks.
Earned Income Tax Credit
The maximum amount for households who claim the Earned Income Tax Credit will be $7,430 for those who have at least three children, compared with $6,935 in the current tax year, the IRS said.
Capital gains tax brackets
Capital gains — the profit from investments or other assets — are taxed using different brackets and rates than earned income. The income thresholds for capital gains taxes are also being adjusted due to inflation, the IRS said.
For instance, in 2022 single taxpayers who earn below $41,675 aren't required to pay capital gains taxes on their investments. That threshold will rise about 7% to $44,625 in 2023. Single taxpayers who earn above that amount are subject to a 15% capital gains tax, while those who earn above $492,300 in 2023 will be subject to the top capital gains rate of 20%.
Bigger gift exclusion
People can also give up to $17,000 in gifts in 2023 without paying taxes on the money, up from $16,000 in the current year.
Estate tax limit
The estates of wealthy Americans will also get a bigger break in 2023. The IRS will exempt up to $12.92 million from the estate tax, up from $12.06 million for people who died in 2022 — an increase of 7.1%.
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