By Andrew Keshner
‘You can’t put a February 2024 tax refund in the gas tank,’ tax lawyer says
In an era of rising costs, the Internal Revenue Service has just raised income tax brackets for next year.
It can sometimes seem difficult to tie the IRS to the concept of good news, but the adjustments for 2023 income tax brackets, the widely used standard deduction, and about 60 other inflation-indexed tax provisions could be l one of these periods.
How? The large upward adjustments could create a chance to keep more money when you file your 2024 tax return on next year’s income.
The payment on the standard deduction jumps 7% from 2022 to 2023, according to IRS figures. The standard deduction becomes $27,700 for a married couple filing jointly, an increase of $1,800 from this year’s payment. It will increase to $13,850 for individuals and for married couples filing separately, an increase of $900.
Similarly, income brackets on the tax code’s seven marginal tax rates will increase by 7% for the 2023 tax year. Adjustments are based on averages of one of the government’s inflation indicators. .
Here’s how the new tax brackets will affect household income, according to Timothy Steffen, director of tax planning at Baird Private Wealth Management:
“Bracket inflation adjustments mean that it will be harder for taxpayers to reach those higher brackets, and therefore will have more income taxed at lower rates next year,” did he declare.
In other words, “bracket changes mean that more income is taxed at lower rates or, conversely, less income is taxed at higher rates,” said Andy Phillips, director of the H&R Block Tax Institute (HRB). “The more generous standard deduction serves to reduce taxable income and therefore reduce taxes,” Phillips added.
But don’t get carried away by the silver linings of the tax code over four decades of high inflation rates, said tax attorney Adam Brewer. September’s annual inflation rate was 8.2%, according to government data
The IRS adjustments are “good news for taxpayers. It’s just not good enough news, I would argue. Whoever saves money on this, you’ll get a bigger refund in 2024,” said Brewer, of AB Tax Law. But that’s cold comfort now, he added. “You can’t put a February 2024 tax refund in the gas tank.”
Adjustments have a lot of implications, but let’s start with some basics.
There is a possibility of tax savings
The effective rates applied to the income tax brackets remain at 10%, 12%, 22%, 24%, 32% and 35%. But the nominal dollar amounts attached to each tranche are increasing. Now suppose that household income remains the same in 2022 and 2023, even though the next highest tax bracket is further away.
Of course, this is an assumption that might not fully correspond to the tight labor market. Many employers cut higher wages to retain staff. But the tax question is where the wage increase lands in relation to the upward-adjusted tax brackets.
“The idea here is not that people will pay less tax,” said Howard Gleckman, senior fellow at the Tax Policy Center. “The idea is to keep your tax liability relatively stable” and avoid what’s called “bracket creep” where inflation pushes someone into a bigger tax bill when they don’t have not have the spending power to afford it.
“Taxpayers whose incomes have remained stable will pay less tax on the same income because of the progressive tax schedule,” Brewer said. “From a strictly tax point of view, yes, they have tax savings. The bad news is that salaries have remained stable while everything else has increased.”
This could push even more people to use the standard deduction
At tax time, people can choose between standard deduction and itemized deductions. The latter includes write-offs such as charitable contributions, state and local taxes, interest paid on mortgages, and medical expenses.
It makes fiscal sense to itemize when the sum of potential write-offs is greater than the potential payment of the standard deduction. Nearly 14% of taxpayers itemized deductions on their 2019 tax returns and they were generally wealthier, analysis by the Tax Foundation finds
Accelerating spending with itemized deduction potential could be a strategy to reap the tax benefits now, he said. (The charitable contribution write-off for taxpayers who took advantage of the standard deduction expired at the end of last year.)
2023 Retirement Account contribution limits are a huge leap
The inflation adjustments for the 2023 tax year announced on Tuesday were one piece of the tax planning puzzle.
There’s also the question of how much the IRS is going to let savers save in retirement accounts like 401(k), IRAs, and income thresholds for possible deductions. This year, individuals can put up to $20,500 into their 401(k), an increase of $19,500. (The catch-up provisions save workers over 50 an additional $6,500 for a total of $27,000 this year.)
On Friday, the IRS released the 2023 contribution limits on 401(k), IRAs and other retirement savings accounts.
Ahead of the announcement, Steffen and Gleckman said there was a good chance the increases would be significant, in light of inflation adjustments to other provisions.
They were right. The IRS says people can put up to $22,500 in 401(k) accounts next year and up to $6,500 in IRAs. These are nearly 10% and 8% increases over the limits set for 2022.
It’s “important” but not “critical” to know future 401(k) and IRA contribution limits ahead of the upcoming calendar year, said Julie Virta, senior financial advisor at Vanguard Personal Advisor Services, ahead of the announcement. Friday of next year’s contribution limits. The main goal is to pour as much as possible into current contributions, she said.
“We typically tell clients to aim to save between 12% and 15% of their salary through retirement savings vehicles,” Virta said. “By the end of the year, 401(k) investors should assess where their account is and determine if they can increase contributions. For IRAs, investors have a bit more time to the extent where their 2022 contribution deadline is April 15 next year.”
(END) Dow Jones Newswire
Copyright (c) 2022 Dow Jones & Company, Inc.