A Little Light Ahead as IRS Adjusts Tax Rules to Help Offset Inflation

Filing system with the focus on the label that says income tax

If you’re nearing retirement, you probably know the importance of planning ahead. In fact, beginning your retirement planning years in advance is crucial to ensuring your best chance of retirement success. Sure, saving and investing throughout your working years are a must, but reaching your ideal retirement also means pulling all of the pieces together into a complete retirement system. This means figuring out how to turn your big pile of savings into a lifetime income stream. How and when to start taking Social Security benefits to optimize its value over your lifetime. How you can position your assets to reduce how much you contribute to the IRS in taxes in retirement. And the list goes on. A retirement system doesn’t just create itself the year you leave the workforce; it takes years of vision, preparation and sacrifice.

I was thinking about this recently as I spoke to my oldest daughter, Maeve, who is approaching her final semester at Quinnipiac University and ready to begin her career in nursing. Maeve knew from day one of college that she wanted to working in nursing and threw herself into her studies. As we spoke, she reminisced about all the late nights studying, missed parties and unpaid intern work necessary to get to her end goal. It took planning and patience, but the end reward will be ultimately worth it.

As I read about some upcoming changes to the tax rules, I see a similarity. The updated rules present us with a little light at the end of our current economic “tunnel”, but we have to be patient – and have a strategy for it. 

You see, the IRS has announced that it is adjusting a number of current rules to help us better weather the impact of the current inflation, and this will mean some real tax savings for some taxpayers next year. As Americans struggle to manage their budgets and still make ends meet during tremendous inflation, these changes are likely to be more impactful than they might be in a typical year. Many, but not all, dollar figures in the tax code are adjusted annually for inflation. When inflation is high, tax deductions and credits that don’t change automatically lose their value more quickly. To address this, the IRS makes certain adjustments annually, and with prices currently surging and our wages lagging behind, these changes are welcome relief. The catch here? While these new rules take effect in 2023, we won’t realize their benefits until we file our taxes in 2024 – so we need to practice a little patience here to reap the benefits.

And one of the biggest benefits will be higher provisional income thresholds, which determine your tax bracket for the year. These higher limits are intended to help avoid what’s called “bracket creep” due to inflation, which can push those who received annual cost-of -living pay increases into higher tax brackets even though their standard of living hasn’t changed. The standard deduction is used by people who don’t itemize their taxes, and it reduces the amount of income you must pay taxes on. 

The standard deduction will climb to $27,700 for married couples and $13,850 for individuals, both also up about 7% from this year, letting taxpayers shield more of their earnings from income taxes. The 37% top marginal tax rate will apply to individual income above $578,125 and married couples’ income above $693,750 next year, as those thresholds go up 7% from 2022 under inflation adjustments. This is the largest automatic adjustment to the standard deduction since core features of the tax system were first indexed to inflation in 1985.

As an example of how this will play out, let’s look at a single taxpayer who earns $110,000. In 2023, she will take a standard deduction of $13,850, reducing her taxable income to $96,150. She’ll pay 10% tax on her first $11,000 of income, 12% tax on income from $11,000 to $44,735, 22% tax on the portion of income from $44,735 up to $95,375, and 24% tax on the portion of her income from $95,374 to her limit of taxable income.  Together, she’ll pay the IRS $17,063 in taxes, which gives her an effective tax rate of 17.7% on her taxable income.

There are other tax breaks too. Capital gains, which are the profits you earn from investments or other assets, are taxed using different brackets and rates than earned income. The income thresholds for capital gains taxes are also being adjusted due to inflation. That threshold will rise about 7% to $44,625 in 2023. Single taxpayers who earn above that amount are subject to a 15% capital gains tax, while those who earn above $492,300 in 2023 will be subject to the top capital gains rate of 20%.

The gift tax exclusion is also increasing. You can give up to $17,000 in gifts in 2023 without paying taxes on the money, up from $16,000 in 2022. And the estates of wealthy Americans will also get a bigger break in 2023. The IRS will exempt up to $12.92 million from the estate tax, up from $12.06 million for people who died in 2022 — an increase of 7.1%.

The bottom line here is that many of us will benefit from some welcome tax changes – in 2024. Use the time now to review your retirement and tax situation so you’re better positioned to take advantage of them. I’m confident you’ll find that a little patience and planning now will be well worth it!

And as always – be vigilant and stay alert, because you deserve more!

Have a great week folks.

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield, MA. 

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