For the greater part of 2022, inflation has been at the top of most headlines. Now, as 2022 comes to an end, it may be surprising to discover that inflation can affect tax planning. The tax code is written so that many areas are tied to inflation.
In mid-October, the IRS released calculations for 2023 tax brackets in response to higher inflation. Here, we cover adjustments to income thresholds for each tax bracket and the standard deduction that has been adjusted.
Inflation and Ordinary Tax Brackets
As of Sept. 30, 2022, inflation for the previous 12 months was calculated at 8.2%. When the IRS announced the 2023 Tax Brackets, the result was a rounded average of a 7% increase from the 2022 values. To some, this may sound like a big shift, while the effect is immaterial to others. Looking at how much each taxpayer’s income is anticipated to increase in 2023 compared to 2022 as well as where one is in their tax bracket is likely to influence their interpretation. For example, the impact of a 7% inflation increase for single and married filing jointly (MFJ) taxpayers doesn’t change for those below the 24% tax bracket, but the greatest potential impact is for taxpayers in the upper 35% to lower 37% brackets.
Taxpayers are entitled to a standard deduction or are able to itemize their deductions. The Standard Deduction is a reduction to ordinary taxable income and like tax brackets, increases with inflation. In 2023, the Standard Deduction is set to increase at a rounded average of 7% over the 2022 values.
Capital Gains Tax Rates
Tax tables can feel intentionally complicated because in the U.S., we not only have graduated tax rates but we also have multiple classifications of income, each with its own set of rules.
In the example above, we discussed a taxpayer with W-2 wage income only. The reason to distinguish between wage/earned income and income derived from investments is there can be special rules for investment income. This secondary tax bracket is the Maximum Capital Gains Rate in the tax code, and often referred to as the capital gains tax bracket. Capital gains tax brackets apply a lower tax rate to income than those previously discussed. The two most common types of investment income that qualify for these lower tax brackets are long-term capital gains (property held for greater than one year) and Qualified Dividend Income.
The increase to the 2023 maximum capital gains rate was also rounded to an average of 7% over 2022. There is a minimum impact for those who have taxable income below $459,000 (single) or $517,000 (MFJ) or those comfortably in the 15% capital gains tax bracket.
Monitoring changes to the tax brackets can result in effective tax savings strategies; however, there are many factors to consider in tax planning. Be sure to contact your financial advisor to discuss planning strategies for 2023.
Lisa Borrelli is a Wealth Planner at Bryn Mawr Capital Management, a subsidiary of WSFS Financial Corp. In her role, Borrelli works with clients on a variety of planning areas such as income tax and liability exposure, business planning, and trust and estate planning. Borrelli is currently pursuing her Masters in Taxation (M.T.) at Villanova University and earned her B.S. in accounting from the Haub School of Business at Saint Joseph’s University. She can be reached at [email protected]