Higher Inflation Could Mean Smaller Tax Bills for Some
The latest data from the U.S. Bureau of Labor Statistics doubles down on what has become 2022’s loudest refrain: Sometimes the race to beat inflation is just a slow crawl.
And while persistently high inflation is hardly cheerful news, a set of annual adjustments that are tied to an inflation index could provide relief in one unexpected area — taxes.
Keeping bracket creep at bay
Typically in early November, the IRS releases a swath of adjustments to various tax provisions, including tax brackets, standard deductions and certain tax credits for the forthcoming tax year.
These adjustments are tied to the Chained Consumer Price Index for All Urban Consumers, or C-CPI-U, and the IRS’ goal is to prevent bracket creep. In other words, these annual tweaks allow the IRS to ensure that inflation doesn’t eat away at the original basis for a tax credit or threshold.
Take, for example, a married couple filing jointly with a taxable income of $80,000. In 2022, this would put the taxpayers in the 12% tax bracket. If that couple together were to receive a $10,000 pay bump as a cost-of-living adjustment in 2023 and no changes were made to the brackets, that raise would push a portion of their earnings into the next bracket, to be taxed at a higher rate of 22%.
By adjusting the income thresholds each year to account for inflation, the IRS is acknowledging that the economic landscape is changing and that you should not be penalized if your salary’s purchasing power essentially remains the same, says Mark Luscombe, a certified public accountant and principal federal tax analyst for Wolters Kluwer Tax and Accounting in Riverwoods, Illinois.
What’s expected to be different in 2023
This year’s historic rate of inflation has affected about everything — including projections of the adjustments that will come from the IRS this fall. Several tax analysts are anticipating a roughly 7% increase across numerous tax provisions, compared with a 3% increase last year.
Sizable tax bracket adjustments
Perhaps the most significant callout from the projections is a considerable adjustment to income thresholds across all filing statuses for 2023. According to Wolters Kluwer projections, those who are married filing jointly, for example, might see the ceiling for the 12% tax bracket rise from $83,550 in 2022 to $89,450 in 2023. This could help keep some folks out of a higher tax bracket (and potentially a higher bill).
Also likely is a larger-than-usual bump to the standard deduction, a flat amount taxpayers can use to reduce their taxable income. Wolters Kluwer projects couples who are married filing jointly might be able to take up to $27,700 in 2023, up from $25,900 in 2022.
Expanded tax credits
Another bonus we may see is adjustments to certain tax credits, which could mean additional savings for some taxpayers. A Bloomberg Tax analysis projects that the refundable portion of the popular child tax credit could rise from $1,500 to $1,600, and the earned income tax credit, a benefit meant to aid lower-income taxpayers, could jump from a maximum of $6,935 to $7,430 for families with three or more kids.
Higher savings contribution limits
Taxpayers may also get a chance to increase their contributions to certain tax-advantaged accounts, which in some cases can also lower their taxable income.
Per Bloomberg Tax, you may be able to contribute up to $6,500 in 2023 to an IRA (up $500 from 2022). Those 50 or older also generally get a catch-up contribution that lets them funnel in an extra $1,000. As for contribution limits for employer-sponsored retirement accounts, like 401(k)s, Luscombe says we should expect similarly significant increases. The IRS is expected to release the official numbers in the coming weeks.
Those with health savings accounts, or HSAs — which allow you to contribute a certain amount of your salary pretax for medical expenses — may be able to contribute up to $3,850 for themselves or up to $7,750 for a family in 2023.
Though these adjustments will likely allow taxpayers to take a more generous standard deduction or funnel more money into accounts that could lower taxable income, there’s no guarantee tax bills will be smaller — numerous factors affect your overall tax liability.
It’s also important to note that some tax provisions are not annually adjusted for inflation, Luscombe says. This includes certain tax breaks like the state and local tax deduction, which is capped at $10,000 until 2025, and the capital loss deduction, a provision that allows investors with net losses to lower their taxable income by a max of $3,000 per year.
The bottom line: Changes to the code are meant to act as damage control; folks whose wages may not have kept up with inflation could potentially see a benefit, and those who received a cost-of-living raise may avoid getting bumped up into a higher tax bracket. And a lucky few of us, perhaps, may end up with a lower tax bill.