After several years of low inflation, consumers in the U.S. and around the world have seen their purchasing power pummelled by spiking inflation rates in 2021 and 2022. From 2012 to 2020, inflation hovered around two percent a year. But triggered by the COVID crisis and attendant supply chain problems, inflation soared to seven percent in 2021.1
As of November 2022, the annual inflation rate for the year is at 7.7%, with the additional increase largely due to rising energy costs (a 17% increase) fueled by Russia's attack on Ukraine.2 It's cold comfort for U.S. taxpayers that inflation here is in the middle of the pack for leading industrialized nations. Israel's 2022 inflation rate is the steepest, at 25 times higher than it was just two years ago. Italy and Greece are not far behind.3
The Internal Revenue Service has offered more comfort for strapped U.S. taxpayers. In October, the agency released information on the annual inflation adjustments for the tax year 2023 with several adjustments around 7%. Learn more about the adjustments here.
Annual Inflation Adjustments for Tax Year 2023
The IRS has been making annual inflation adjustments since the 1980s in order to prevent bracket creep. Bracket creep refers to a taxpayer being bumped into a higher tax bracket as a result of a cost-of-living wage adjustment that may not improve the taxpayer's purchasing power. This year's record change in the annual adjustments reflects the dramatic rate of inflation.
The IRS adjusted more than 60 tax provisions. Some of the most salient 2023 annual adjustments are changes to the standard deductions and the income thresholds for tax bracket changes, along with adjustments to the alternative minimum tax exemption and the earned income tax credit.
The tax changes affect the returns that people file in early 2024, and many taxpayers will start to see lower payroll deductions in January as employers withhold at the new tax rate.
The Standard Deduction Rises Approximately 7%
Most taxpayers, about 89% of them, take the standard deduction. The percentage wasn't always so high, but the 2017 Tax Cuts and Jobs Act (TCJA) nearly doubled the standard deduction, making it a much more attractive filing option.4, 5
2023 Tax Year Standard Deduction Amounts
- Single taxpayers and married individuals filing separately: $13,850
- Head of household taxpayers: $20,800
- Married couples filing jointly: $27,7006
While using the standard deduction can save time and tax preparation fees, it isn't available to everyone and it isn't advantageous for every taxpayer. Some of the common itemized deductions that can make a sizeable difference in a person's taxable income include mortgage interest and real estate taxes for a home, significant unreimbursed medical or dental expenses and large contributions to qualified charities.7
Marginal Tax Rates and Income Tax Brackets
The U.S. has a progressive tax system, with income tax liability depending on the amount of a taxpayer's taxable income in a year. There are currently seven tax brackets, with the number of brackets and the marginal tax rate for each set by Congress. The 2017 TCJA set the marginal rates in the following table, and the threshold income reflects the tax year 2023 adjustments.
Tax Rates and Income Thresholds for Single and Joint Filers
|Rate||Filing Single||Filing Joint|
|Rate||Filing Single||Filing Joint|
|10%||Under $11,000||Under $22,000|
Find rate thresholds for head of household filers in the Internal Revenue Service publication, Revenue Procedure 2022-28.
The Effective Tax Rate is Lower Than the Marginal Tax Rate
The Internal Revenue Service calculates a taxpayer's liability on a formula in which the first money earned is taxed at the lowest rate, then the amount that falls in the second bracket taxed at that rate and so on, with only the amount in excess of the threshold limit taxed at the marginal rate.
For example, a couple that is married filing jointly with taxable income of $200,000 falls in the 24% tax bracket. They would be taxed at $32,580 for the first $190,750 and at 24% for the remaining $9,250, yielding an effective tax rate of 17%. Details for all the combinations of income and filing status are available in Revenue Procedure 2022-28.
The Alternative Minimum Tax and the Earned Income Tax Credit
In addition to the tax brackets and progressive tax structure, the U.S. tax code also contains special provisions for those at the opposite ends of the income spectrum. The IRS adjusted the levels of both the alternative minimum tax and the earned income tax credit for 2023.
The earned income tax credit is available s to low and moderate income taxpayers with or without children. The amount is determined by the taxpayer's earnings, filing status (married, single etc.) and the number of children. The credit allowed for qualifying taxpayers in the 2023 tax year ranges from $600 to $7,430.8
Congress enacted the alternative minimum tax (AMT) in 1969 to ensure that wealthy individuals pay their fair share of taxes regardless of the number of deductions and credits they may claim. Under the provisions of the TCJA, which will expire after 2025, the AMT is indexed for inflation.
Briefly, the 2023 alternative minimum tax exemption for single taxpayers is $81,300, and the phaseout begins at $578,150. For married couples filing jointly, the exemption is $126,500 and the phaseout begins at $1,156,300.6
Other Tax Planning Notes
Publication 2022-28 announced several other changes including increases in the amount of credit for qualified adoption expenses; employee salary reductions for medical savings account contributions and health flexible spending arrangements. There are also qualified parking increases Qualified transportation fringe benefit limits are higher as well. Find basic information these changes and others summarized in the Internal Revenue Service press release about the tax inflation adjustments.
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- Retrieved on December 6, 2022, from usinflationcalculator.com/inflation/current-inflation-rates/
- Retrieved on December 6, 2022, from www.bls.gov/opub/ted/2022/consumer-prices-up-9-1-percent-over-the-year-ended-june-2022-largest-increase-in-40-years.htm
- Retrieved on December 6, 2022, from pewresearch.org/fact-tank/2022/06/15/in-the-u-s-and-around-the-world-inflation-is-high-and-getting-higher/
- Retrieved on December 6, 2022, from irs.gov/statistics/soi-tax-stats-tax-stats-at-a-glance
- Retrieved on December 6, 2022, from taxfoundation.org/the-tax-cuts-and-jobs-act-simplified-the-tax-filing-process-for-millions-of-americans/
- Retrieved on December 6, 2022, from https://www.irs.gov/newsroom/irs-provides-tax-inflation-adjustments-for-tax-year-2023
- Retrieved on December 6, 2022, from irs.gov/taxtopics/tc501
- Retrieved on December 6, 2022, fromirs.gov/pub/irs-drop/rp-22-38.pdf