Here’s how persistent high inflation may affect your tax bracket next year

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As Americans grapple with soaring prices, experts say it’s likely we’ll see higher than usual inflation adjustments from the IRS for 2023 — covering tax brackets, 401(k) plan contribution limits and more.

Built into the tax code, these yearly IRS changes aim to prevent so-called “bracket creep,” when inflation bumps up income and pushes Americans into higher tax brackets, explained Kyle Pomerleau, senior fellow and federal tax expert with the American Enterprise Institute.

“That’s not necessarily a good thing,” he said, since Americans’ may not reflect an improved quality of life.

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Typically, the IRS releases inflation adjustments for the following year in October or November, and Pomerleau predicts 7% increases across many provisions for 2023. 

“This year, we’ll see a larger-than-average adjustment because we’ve experienced higher than usual inflation,” he said.  

This includes higher tax brackets and a bigger standard deduction.

For example, the 24% tax bracket may rise to $190,750 of taxable income for joint filers in 2023, up from $178,150 for 2022, Pomerleau estimates.

This year, we’ll see a larger-than-average adjustment because we’ve experienced higher than usual inflation.

Kyle Pomerleau

Senior fellow with the American Enterprise Institute

There may also be a higher exemption for so-called alternative minimum tax, a parallel system for higher earners, and more generous write-offs and phase-outs for the earned income tax credit for low-to-moderate income filers and more.

And the estate tax exemptions may rise to $12.92 million and $25.84 million for single and joint filers, respectively, up from $12.06 million and $24.12 million, Pomerleau predicts.

However, that’s not a guarantee of smaller tax bills for 2023.

“It’s going to depend on the taxpayer,” said Pomerleau, pointing to different types of income, how much earnings have inflated and which provisions may apply.

Retirement account contribution limits may increase

Higher inflation adjustments may also benefit retirement savers, with larger contribution limits for 401(k) and individual retirement accounts, Pomerleau said.

While it’s too early to predict 401(k) deferral caps, he expects annual IRA limits to jump to $6,500 for savers under 50, up from $6,000 for 2022.

“The jump for the IRA contribution limit is closer to 8% or 9% this year because of the way it interacts with the rounding rule,” he said, explaining it adjusts in $500 increments.

Some tax provisions still won’t adjust for inflation

Despite above-average inflation adjustments for many provisions, several remain the same every year, experts say.

“It’s a hodgepodge of things that get left out,” said certified financial planner Larry Harris, director of tax services at Parsec Financial in Asheville, North Carolina.

There’s a 3.8% surcharge on investment income, kicking in when modified adjusted gross income passes $200,000 for single filers and $250,000 for couples, which hasn’t been adjusted.  

And the $3,000 limit for capital loss deductions has been fixed for about 30 years. “Inflation is eroding that away,” Pomerleau said.

While the $10,000 limit on the federal deduction for state and local taxes, known as SALT, will sunset after 2025, the set cap is “having a larger impact in the meantime,” he said.

However, it’s difficult to gauge exactly how much any single provision may affect someone’s tax bill without running a 2023 projection, Harris said.

Source: CNBC


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