Inflation has been making many parts of our lives more expensive – cars, food, and home prices are a couple of areas that immediately come to mind. Policymakers are attempting to lower inflation by raising interest rates. This has been especially painful for those looking for a mortgage or a car loan.
However, there may a be a small silver lining. The IRS sets tax brackets, tax deductions and retirement account contribution limits based on inflation. Depending on all the moving pieces in your financial picture, this could result in a lower tax bill. In this article, we will look at the impact of inflation on taxes this year and some planning opportunities resulting from it.
Tax Brackets Are Heading Up
Tax brackets are moved up due to inflation to ensure that they reflect people’s real income. Inflation means credits, deductions, and exemptions are worth less, which translates to an increase in taxes paid. Raising the amount of the income range in each bracket shelters more income from higher rates.
The amount of the increase each year is often small enough that it doesn’t affect most people’s tax brackets, however, this year the brackets increased by around 7%. This increase means that a couple won’t start paying a 22% federal income tax rate until they exceed $89,450 in taxable income compared to $83,550 last year.
The Standard Deduction Is Increasing
Filing your taxes may also have gotten simpler. The standard deduction – the amount you are entitled to claim without itemizing – increased to $13,850 for single filers in 2023. For married couples filing jointly, the new deduction amount is $27,700. If you don’t usually itemize, this is probably good news as you will get a larger deduction. However, if you do itemize, you may find that some of your regular deductions, such as state and local taxes or gifts to charity, are no longer tax benefits.
One solution may be to bunch your charitable gifts. “Bunching” refers to grouping donations intended for several years into a single year. This strategy is only effective if all your itemized deductions, including the bunched gifts, are more than the standard deduction. A donor-advised fund can be a helpful tool to pursue this strategy.
Retirement and Healthcare Savings Contributions on the Rise
Contribution limits for workplace retirement accounts and IRA accounts increased 8%+ in 2023. This boost allows more dollars to go in tax-advantaged accounts. Those over age 50 benefitted especially as they can now contribute $30,000 each year to a workplace retirement account (such as 401(k), 403(b), and 457 plans), up 11% from last year.
Depending on how much you earn, you may be able to contribute to an IRA account this year even if you weren’t able to in prior years. For example, the phaseout for a married filer to contribute to a Roth IRA now starts at a modified adjusted gross income of $218,000. Five years ago, the income limit was $189,000.
Health Savings Accounts (HSAs) have higher maximum contributions as well. An individual can contribute up to $3,850, and the family contribution has risen to $7,750. These accounts are referred to as “triple-tax-advantaged”. Contribution dollars are pre-tax, the accounts grow tax-free, and qualified withdrawals are also not taxed.
Flexible health spending accounts saw a bump of $200 this year, allowing you to contribute $3,050 of pre-tax dollars to this type of account to pay for medical costs that aren’t covered by insurance.
There is One Catch
Social security benefits increased as well, which may be good news for retirees. However, if you’re still working, you’re still paying into the system. Social security taxes are 6.2% of income, up to a maximum earnings ceiling. The maximum amount of earnings subject to social security taxes increased by almost 9%, to $160,200 in 2023, from $147,000. This translates to a dollar amount of $9,932, up from $9,114 in 2022.
High inflation has been painful over the last few years as we’ve seen our cost-of-living rise. However, this inflation has presented some benefits from a tax-planning perspective. By taking a proactive approach to planning, you can maximize the opportunities presented by these changes in tax rules. If you would like to talk with a financial planner about your tax strategy and ways to lower your tax bill, please schedule a call with us here.
Sources: Internal Revenue Service
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