IRS adjustments may save you some money in 2023
Are expensive gas and groceries busting your budget? The Internal Revenue Service feels your pain. In one of the few silver linings of the highest inflation rates in four decades, the IRS announced inflation-adjusted changes to 2023 tax rules that could mean smaller tax bills for returns filed in 2024.
The Consumer Price Index (CPI) is more than just a measure of the change in prices of cereal, chicken and cars. Each year, the IRS takes the rate of inflation into account when determining the tax rates Americans pay. In the latest annual adjustments, Uncle Sam not only is giving taxpayers a break by boosting the standard deduction and raising income levels for each tax bracket, he’s including perks that could result in larger take-home pay and lower tax bills.
“This is a silver lining of the high inflationary environment,” said Lisa Featherngill, national director of wealth planning for Comerica Bank.
A lot of financial things are tied to fluctuations in inflation, including annual Social Security benefit increases, the interest paid on U.S. I bonds, and tax changes that impact Form 1040. For example, the U.S. government already announced that Social Security recipients will receive an 8.7 percent cost-of-living adjustment in 2023 to offset higher inflation. On Nov. 1, the U.S. Treasury will set the new interest rate on I bonds for the next six months. (I bonds currently yield 9.62 percent; DepositAccounts.com expects that the new rate, from Nov. 1 to April 30, 2023, will be 6.48 percent.)
Most add up to savings
Changes in the tax code to account for inflation affect the most people. Here are 12 IRS changes for tax year 2023, for returns filed in 2024, that could save retirees and pre-retirees money and offset the financial hit of higher consumer prices:
1. TAX BRACKETS
While the 2023 tax brackets remain the same — at 10 percent, 12, 22, 24, 32, 35 and 37 percent — the income level for each tax bracket has increased 7.1 percent. “That means more income will hit at [lower tax brackets] before you hit the higher brackets,” said Robert Seltzer, CPA, president of Seltzer Business Management. For example, an additional $12,600 of a married couple’s income in tax year 2023 would not fall into the higher 32 percent tax bracket as it would this tax year.
2. THE STANDARD DEDUCTION
Joint filers who don’t itemize deductions on their return for 2023 will see an $1,800 reduction in their taxable income compared with a year ago. “For a married couple in the 24 percent tax bracket, that puts roughly $425 to $450 more in your pocket,” Seltzer said.
3. RETIREMENT PLAN CONTRIBUTIONS
The amount you can save in retirement accounts will increase. Although the IRS hasn’t announced the contribution limits for 2023, expect a substantial jump. Last year, the government increased the amount you could contribute to a 401(k) by $1,000, to $20,500. Those 50 and older may get an increase to the catch-up amount, currently $6,500. The amount you can contribute to individual retirement accounts should rise as well.
4. HEALTH SAVINGS ACCOUNTS
The dollar limit for pretax contributions to health savings accounts has increased by $200 to $3,850. As a result, you get to pay for more health expenses like doctor copays and out-of-pocket prescription costs with income that isn’t taxed by the U.S. government.
5. EARNED INCOME TAX CREDIT (EITC)
For low- to mid-income families with three or more qualifying children, the maximum earned income tax credit jumps to $7,430, from $6,935. The credit reduces your tax dollar for dollar. Even better, EITC is a refundable tax credit, which means that even if you don’t owe any tax, you can still receive a refund.
6. ALTERNATIVE MINIMUM TAX (AMT)
The IRS has raised the income threshold for the AMT to $126,500 for married couples filing jointly, versus the prior $118,100. That means your income can be higher but still avoid the AMT tax. The AMT threshold for single filers is rising from $75,900 to $81,300.
7. ESTATE TAX
The per-person estate tax exclusion for someone who dies in 2023 has increased to $12.92 million, up from $12.06 million, which means an additional $860,000 of a person’s total estate will be shielded from the 40 percent federal estate tax on amounts that exceed the IRS threshold. “I have never seen such a huge increase,” Featherngill said. “For some people this is going to be good news.”
8. GIFT EXCLUSION
The annual exclusion for gifts increases to $17,000, up from $16,000, which can help you avoid estate taxes by giving away more money before you die.
9. ADOPTION CREDIT
The maximum credit allowed for adoptions and related qualified expenses rises to $15,950 from $14,890.
10. FOREIGN EARNED INCOME
Americans who earn income outside the U.S. (and more do in the work-from-home world we live in since COVID) will also benefit from an increase in the foreign earned income exclusion to $120,000, a hefty $8,000 more than in the prior year.
11. SOCIAL SECURITY PAYROLL TAXES
This is one CPI adjustment that will cost you more. Employees pay 6.2 percent of their income to fund Social Security, and employers pay the same. (The self-employed pay the full 12.4 percent). The maximum amount of earnings subject to the Social Security tax will increase next year from $147,000 to $160,200.
12. VETERANS BENEFITS
As with Social Security, veterans benefits will increase 8.7 percent with inflation. For a veteran receiving about $1,500 in monthly payouts, the increase will mean about $130 extra each month.
The CPI doesn’t only affect taxes and government benefits. Employers often base their annual raises on the CPI. And while not directly impacted by IRS rules, many landlords use an inflation index clause that adjusts rents to correspond with changes in inflation, says Dan Casey, owner and investment adviser at Bridgeriver Advisors. “Landlords,” he said, “are able to raise rates because of the CPI number as well.”
While all these inflation adjustments might not make up for all the $5-per-gallon fill-ups and pricey restaurant meals in the past year, the changes will offset some of the financial outlay due to higher inflation. “It does take some of the sting out of the inflation that we have all been experiencing,” Seltzer said.