How Inflation Affects 2023 Tax Brackets: You May Get a Windfall ‘Tax Cut’

As you probably know, federal income tax rate bands, and many other federal tax parameters, are adjusted for inflation using a factor based on the monthly average of changes in the chained Consumer Price Index or chained CPI. Because of the way they are calculated, increases in CPI chain numbers during inflationary periods, such as now, are slightly lower than increases in normal CPI numbers you read about in the media. But the differences are relatively minor. To keep things simple in this column, let’s just call the chained CPI as CPI and go with it. OKAY? Forward.

As you may have noticed, inflation has soared this year, and that will be reflected in the monthly CPI numbers that will be used to calculate the inflation adjustment factor for the 2023 federal income tax brackets. These brackets and other inflation-adjusted federal tax parameters will likely to be announced in November. They will be based on the monthly average of CPI changes during the federal government’s fiscal year that began in October last year and will end in September this year.

Impact of inflation on 2022 and 2023 tax escalations

For the 12 months used to calculate the inflation adjustment factor for tax year 2022, inflation was mild in the first half and only started to be higher in the second half. As a result, the inflation adjustment factor for 2022 was only about 3.1%. For example, the starting 24% rate bracket for a married couple filing jointly is $178,150 of taxable income for 2022. That’s 3.13% higher than the corresponding figure of $172,750 for 2021. Basically, ho hum.

That was then. This is now. You won’t be surprised to hear that there will be a much higher inflation adjustment for fiscal year 2023. By my calculations, we’re headed for an inflation adjustment of about 7%. Maybe more, depending on how inflation moves through September. For the eight months considered so far, we’re looking at a rate of around 7.1%. Assume that the inflation adjustment factor for tax year 2023 will be 7%.

How would this affect your personal federal income tax situation? Please continue reading.

Inflation-adjusted estimates for your 2023 tax year

With an assumed inflation adjustment factor of 7%, all federal income tax brackets will increase by approximately 7%. Will not be exactly 7% because the federal tax parameters are adjusted for certain rounding dollar increases. For example, tax bracket numbers adjust in $25 increments, but standard deduction numbers adjust in $50 increments. Annual contribution limits for your 401(k) account adjust in $500 increments. The consolidated federal estate and gift tax exemption numbers are adjusted in $10,000 increments.

Going right, an assumed inflation adjustment factor of 7% would increase in 2023 tax rate brackets as follows:

Common Filers

Singles

Family heads

End of the 10% bracket.

$22,000

$11,000

$15,650

12% bracket principle.

$22,001

$11,001

$15,651

Beginning of races 22%.

$89,401

$44,701

$59,800

Beginning of races 24%.

$190,601

$95,301

$95,301

Principle 32% arm

$363,901

$181,951

$181,951

Principle 35% arm

$462,201

$231,101

$231,101

Principle 37% arm

$693,201

$577,701

$577,701

Effect: Other things being equal, you could have 7% more taxable income next year and have the same federal income tax as this year. Beautiful. While almost no one likes inflation, it is an evil wind that blows no good, as the saying goes.

An assumed inflation adjustment factor of 7% would increase in 2023 typical discount amounts as follows:

Common Filers

Singles

Family heads

$27,700

$13,850

$20,750

Effect: If you don’t itemize deductions, your standard deduction will shield 7% more income from federal income tax next year. Good.

An assumed inflation adjustment factor of 7% will increase its peak 0% Federal Income Tax. for the 2023 long-term capital gains and dividends as follows:

Common Filers

Singles

HOH

$89,200

$45,600

$59,700

Effect: With other things, you could have 7% more in long-term capital gains and dividends free of federal income tax next year. Good.

An assumed inflation adjustment factor of 7% would increase his principle 20% top federal income tax bracket for the 2023 long-term capital gains and dividends as follows:

Common Filers

Singles

HOH

$553,401

$491,901

$522,701

Effect: You’d have a better chance of avoiding the 20% maximum rate next year. Good.

And there are more

An assumed inflation adjustment factor of 7% would increase the maximum 401(k) contribution from the current $20,500 to $21,950 next year. Good.

An assumed inflation adjustment factor of 7% would also increase several other federal tax parameters, such as the 2023 phase-out ranges for deductible contributions to traditional IRAs, the 2023 phase-out ranges for contributions to Roth IRAs, the 2023 phase-out ranges for qualified business income (QBI) deduction for small business owners and the consolidated federal gift and estate tax exemption for you 17 dear readers who will be affected by this.

That’s all good — as long as you’d rather pay less tax next year than more.

Can you take this “good news” to the bank?

Oh no. Previous taxpayer-friendly estimates assumed there would be no new legislation affecting your federal tax position in 2023. However, there are rumblings from D.C. that some Democrats, including West Virginia Sen. Joe Manchin, are discussing a watered-down version of President Biden’s ill-fated “Build Back Better (BBB)” bill. A revamped BBB could include federal tax increases – such as raising the top income tax rate from the current 37% to 39.6%, starting next year. There could be other adverse changes for some taxpayers if something passes our beloved Congress.

The bottom line

Don’t be arrogant. Stay tuned for possible negative developments. Needless to say, we’ll keep you posted.

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