The Internal Revenue Service has announced several inflation changes impacting individual income tax rates, deductions, and credits for 2023, and it should come as no surprise that today’s four-decade-high inflation has resulted in some significant increases.
Consider the standard deduction, which is currently used by more than 85% of taxpayers in place of itemized deductions. The deduction for married couples filing jointly will increase to $27,700 in 2023 from $25,900 in 2022; for individuals and couples filing separately, it will increase to $13,850 from $12,950; and for the head of household, it will increase to $20,800 from $19,400. (A single adult who has children or other dependents is known as the head of the home.) For those 65 and over, the additional standard deduction will increase from $1,400 per person in 2022 to $1,500 per person in 2023. If the senior is single, the additional deduction will increase to $1,850 in 2023 from $1,750.
In the meanwhile, both the regular income and capital gains tax bands for individuals will increase in 2023. Therefore, the first $22,000 of taxable income for a married couple filing jointly will be covered by the lowest 10% regular income tax level, up from $20,550 in 2022. The top 37% rate will be applied to taxable income surpassing $693,750, up from $647,850 in 2022, while the couple’s 24% bracket will start at $190,750, up from $178,150.
The full list of ordinary income tax brackets for 2023, which includes salaries, self-employment income, and interest, appears at the bottom of this article. Keep in mind that 1040 you submit at the beginning of 2023 will be subject to the 2022 rates.
Since 1985, the individual federal tax rates have been automatically adjusted for inflation; this rule was established in 1981, following a period of inflation that was far higher than what the nation is currently experiencing. Inflation shouldn’t unnaturally drive people to higher tax levels, which is why the modifications were made. In other words, those whose income hasn’t climbed in line with inflation may find themselves paying taxes at lower rates in 2023 than they did in 2022, somewhat making up for the losses they’ve suffered.
The income thresholds at which taxes on Social Security payments take effect, however, are a crucial component that isn’t indexed. The result is that retirees with more modest incomes will pay federal taxes on their 2023 benefits, which will be increased by an 8.7% cost of living adjustment.
A married couple won’t pay any tax until their income (including those gains) is over $89,250, up from $83,350 in 2022, regarding the tax rate on eligible stock dividends and long-term capital gains (that is, earnings on equities held more than a year). The profits rate is 15% over that. Over $553,850 for a couple in 2023, up from $517,200 in 2022, the highest gains rate of 20% will take effect. The 15% capital gains and dividends rate for individual filers begins to apply on income over $44,625 in 2023, up from $41,676 in 2022. However, single people won’t be subject to the top 20% rate until their income hits $492,300 in 2023, up from $459,760. (Yes, that is greater than half of the level for married couples. One of the areas where the tax code still imposes a marital penalty is the highest gains rate, and no, you cannot get around it by filing separately from your spouse.)
Several significant credits are additionally adjusted for inflation. The maximum earned income tax credit, for instance, will increase from $6,935 in 2022 to $7,430 in 2023 for eligible taxpayers with three or more children. The credit increases with earned income and starts to gradually phase out at relatively low-income levels. It is intended to assist working poor families. In 2023, for instance, a married couple with three children would start to lose some of their EITC at an income of $28,120, but they won’t completely lose it until their income reaches $63,398.
The IRS Revenue Procedure 22-38 contains a list of all the modifications. (It is a 28-page document that covers everything from the adoption credit to fines for failing to submit some returns by the deadline.)
Because of inflation, wealthy people will also be able to leave their heirs a larger sum of money tax-free during their lifetime or after death. One significant difference in gifting is that, instead of worrying about exhausting your lifetime gift and estate tax exemption or paying gift tax, you can now give anybody else (and as many people as you like) $17,000 in gifts in 2023, up from $16,000 in 2022. This lifetime exemption will increase from $12.06 million in 2022 to $12.92 million in 2023. (Read more about the changes to the estate and gift taxes here.)