You might not like filling out your federal tax return, but some big changes caused by Inflation will likely help your return in 2023.
Why do adjustments for Inflation matter?
Every year, the Internal Revenue Service (IRS) changes over 60 federal tax provisions, such as exemptions, exclusions, deductions, and credits, affected by Inflation. Ultimately, these rules affect how much you have to pay in taxes.
Because of this, it's important to plan how you file your taxes. The only way to ensure you claim the most cost-effective combination of available provisions is to be well-informed and thorough. Because the Internal Revenue Code is so difficult, this usually means hiring a tax professional.
Why are there Inflation Adjustments?
The Consumer Price Index measures how much income and prices of goods and services have increased over time. The IRS uses inflation adjustments to account for this (CPI). As Inflation increases your income, the IRS tries to tax it in a way that makes economic sense from year to year.
At the same time, the IRS tries to make sure that you can claim exemptions, deductions, and credits in a way that is fair from an economic point of view. Overall, the adjustments for Inflation should not be seen as either bad or good.
Instead, they are meant to ensure that the tax code keeps up with economic changes. Also, be mindful of and react to changes in Inflation. Find the five most important inflation adjustments that might change your tax bill in 2023.
The Tax brackets
Most tax filers will be affected by the inflation adjustment to tax brackets. Tax brackets are ranges of income that correspond to different tax rates in the United States progressive income tax system. The tax brackets increased by about 3.0% for all filing types in 2022. This is much more than the roughly 1% increase planned for 2021.
The standard deduction is another tax code that will change because of Inflation. Recent data from the IRS show that nearly 90% of people who file their income taxes claim this deduction. The rest list each deduction they claim. For single taxpayers and married public filing individually, the standard deduction for 2022 is $12,950, which is $400 more than in 2021.
This is an increase of 3.2%. The inflation adjustment for people who file as “head of household” is $19,400, $600 more than in 2021. For married couples who file jointly, the adjustment is $25,900, which is $800 more than in 2021. Both statuses show an increase of 3.2% from one year to the next.
Contribution Limits for Employer-Paid Retirement Plans
The third adjustment is the annual contribution restrictions for employer-sponsored retirement plans like 401(k), 403(b), most 457 plans, and the federal government's Thrift Savings Plan. For 2022, the most an employee can put in is $20,500, or $27,000 if they are 50 or older.
This is an increase of $1,000 over the limit for 2021, which is $19,500 ($26,000 for people 50 and older). For traditional plans, the $1,000 increase gives you a good chance to keep more of your income out of the tax system and make your retirement portfolio grow faster over time.
Contributions to a plan set up like a Roth are not tax-deductible. Still, just like with traditional plans, the more you save, the more your money can grow in the long run. The limits listed above are for employee contributions, by the way.
The IRS lets employers put more money into the plans of their employees. For 2022, the total amount you can put into an employer-sponsored plan is capped at $61,00, or $67,500 if you are 50 or older. For 2021, the total amount that can be contributed is capped at $58,000 ($64,500 for people over 50).
IRA Income Phase-Out Ranges
Individual retirement accounts (IRAs), like traditional and Roth IRAs, have the same contribution limits for 2022 as they did for 2021. This is different from employer-sponsored retirement plans. The most you can put in is $6,000; if you are 50 or older, you can put in $7,000. This is the total limit for all of the IRAs you own.
The amount you can put into an IRA hasn't changed, but the income ranges that affect how much you can put in after 2022 have been adjusted for Inflation. For example, the income phase-out range for a traditional IRA for married couples filing jointly in 2022 is between $109,000 and $129,000 if the spouse contributing to the IRA is covered by such an employer-sponsored retirement plan.
For 2022, the phase-out range for an IRA contribution married to someone covered by an employer-sponsored retirement plan is $204,000 to $214,000. In 2021, it was $198,000 to $208,000.
For taxpayers with a workplace retirement plan who are single or heads of household, the phase-out range is now $68,000 to $78,000, up from $66,000 to $76,000 for 2021. For a married person who files a separate tax return and is covered by a career retirement plan, $0 to $10,000 remains.
For single and head-of-household taxpayers, the Roth IRA income phase-out range for 2022 is $129,000 to $144,000, rising from $125,000 to $140,000 for 2021. In 2021, the income range for married couples filing jointly was between $204,000 and $214,000. In 2021, it was between $198,000 and $208,000. The range for married people who file their taxes separately is still $0 to $10,000.
Earned Income Tax Credits
A final adjustment for Inflation is made to the earned income tax credit (EITC), a tax credit for workers with low to moderate incomes that can be refunded. In 2022, the most you can get from the EITC was $6,935. In 2021, the most you could get was $6,728.
But the amount you can claim depends on how you file your taxes, how much money you make, and how many qualifying children you have. Even though not everyone can get this credit, most people can. If you meet the requirements, it's worth going for, especially since the top-end increase for 2022 was set at 3.1%.