Americans can save on taxes this year thanks to a historically large inflation adjustment set by the IRS.
The agency adjusted several of its 2023 tax rules to help taxpayers avoid “bracket creep.” This occurs when workers are pushed into higher tax brackets due to the effect of a cost-of-living adjustment to reduce inflation despite their standard of living not changing. On average, the IRS increased each provision for 2023 by about 7%.
The changes could mean tax savings for some taxpayers, providing some relief at a time when Americans are still grappling with high inflation that is eating away at their purchasing power. For example, some taxpayers may fall into a lower tax bracket as a result of the changes, while those using the standard deduction – 86% of taxpayers rely on – will be able to deduct more of their income from taxation.
For example, a married couple earning $200,000 in both 2022 and 2023 would save $900 in taxes this year because more of their income would be taxed at a lower rate, according to Tim Steffen, director of tax planning with Baird.
This could be a welcome change as this year’s tax returns (for the 2022 tax year) are expected to deliver “tax refund shock” to many Americans due to the elimination of the pandemic tax credit. As a result, refunds could be significantly lower in 2023 than a year ago.
Still, the tax bracket change may not save money for everyone, especially those who saw their income increase by 7% or more, according to the Tax Policy Center, a think tank that focuses on taxes.
Senior Fellow Robert McClelland wrote in a blog post, “If their inflation-adjusted income (also known as real income) increases by 7%, it is preventing them from facing higher taxes.” “
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 lowers the amount of income on which you must pay taxes.
- For married couples filing jointly, the standard deduction is $27,700 for 2023, up from $25,900 in the 2022 tax year. This is an increase of $1,800, or a gain of 7%.
- For single taxpayers and married individuals filing separately, the standard deduction is set at $13,850 in 2023, up from $12,950 last year. This is an increase of about 6.9%.
- The standard deduction for heads of households increases from $19,400 in 2022 to $20,800 in 2023. This is an increase of 7.2%.
“The flip side of this, however, is that itemizing your deductions in 2023 will be difficult,” Stephan said. “That means you’re less likely to get a tax benefit next year from your tax payments, mortgage interest and charitable contributions.”
Most taxpayers take the standard deduction, a more generous deduction especially after the Tax Cuts and Jobs Act of 2017. According to the Tax Foundation, only about 14% of taxpayers filed their taxes after the tax overhaul passed, or a 17 percentage-point decline from before the law.
The IRS raised the tax brackets by about 7% for each type of tax filer for 2023, such as filing separately or as a married couple. The top marginal rate, or the highest tax rate based on income, remains 37% for individual single taxpayers with income above $578,125 or for married couples with income above $693,750.
The lowest rate remains 10%, which affects individuals with an income of $11,000 or less and married couples with an income of $22,000 or less. Below is a chart with the new tax brackets.
The 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 your entire income, but this is incorrect.
Take a single taxpayer who earns $110,000. In 2023, she would take the standard deduction of $13,850, reducing her taxable income to $96,150. This year, she’ll pay:
- 10% tax on his 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 to $95,375 or $11,140
- 24% tax on the portion of his income from $95,374 to the extent of his taxable income, $96,150, or $775
Together, she will pay the IRS $17,063 in taxes, which equates to an effective tax rate of 17.7% on her taxable income.
earned income tax credit
The IRS said the maximum amount to claim the Earned Income Tax Credit will be $7,430 for families who have at least three children, up from $6,935 in the current tax year.
capital gains tax brackets
Capital gains — gains from investments or other assets — are taxed using different brackets and rates than earned income. The income limits for capital gains taxes were also adjusted for 2023 to account for inflation.
For example, single taxpayers earning less than $41,675 in 2022 were not required to pay capital gains tax on their investments. In 2023, that limit increases by about 7% to $44,625. Single taxpayers who earn above that amount are subject to a 15% capital gains tax, while those earning more than $492,300 in 2023 will be subject to a top capital gains rate of 20%.
large gift exclusion
Individuals can also give gifts of up to $17,000 without paying tax in 2023, up from $16,000 last year.
property tax threshold
The wealth of wealthy Americans will also get a big break in 2023. The IRS will exempt up to $12.92 million from estate taxes in the current tax year, up from $12.06 million for those who die in 2022 — an increase of 7.1%.
flexible spending accounts
Flexible spending accounts allow workers to put money away, up to the limits allowed by the IRS, that can be used to pay for medical expenses. Because the money is taken out of their account on a pre-tax basis, it provides tax savings for many workers.
The new IRS limit for FSA contributions for 2023 is $3,050, which is about 7% higher than the current tax year limit of $2,850.
However, most employees set their FSA limits in the fall, meaning workers would have to set higher amounts at the end of last year to take advantage of the higher 2023 limits.