2023 Inflation Adjustments: What Changes is the IRS Making?
It’s no secret that Americans have been squeezed by the rising costs associated with high inflation for the better part of a year. The effects of persistent volatility and declining purchasing power can be felt all around us – at the grocery store, the gas pump, and in investors’ portfolios.
According to the Bureau of Labor Statistics, the consumer price index CPI rose 7.1% from November 2021 to November 2022. As the cost of living remains high, the Internal Revenue Service IRS announced new inflation adjustments for the 2023 tax year. Perhaps most notably, federal income tax brackets have shifted upward by 7%- the largest jump in years.
While these changes are simply meant to keep pace with today’s inflationary conditions, they could still end up having an impact on your financial plan. To understand the what, why, and how of these upcoming adjustments, we first need to understand what inflation is and how it works. After that’s been established, we will break down some of the biggest regulatory updates being made by the IRS in 2023.
What’s Inflation and How Does it Work?
Inflation refers to a widespread rise in prices that causes purchasing power to decrease for individual consumers as well as for businesses. Put simply, if everyday goods and services become more expensive, a dollar can’t stretch as far. Measures of inflation like the CPI aim to capture average price changes for a diverse “basket” of market sectors on a monthly and yearly basis – from the cost of gasoline to the price of groceries.
Despite the high inflation we’re experiencing, the wages of American workers haven’t necessarily risen to account for their decline in purchasing power. When the cost of living threatens to outpace workers’ take-home pay, they tend to spend less, ultimately leading to less growth for the economy at large.
What’s Driving Inflation?
The effects of inflation are relatively easy to understand, but its causes can be far more nuanced. It’s a phenomenon that’s often precipitated by a number of different factors, from fiscal policies to consumer psychology and market pressures.
When we look at what’s driving inflation today, it was likely kickstarted by the Covid-19 pandemic. The pandemic-imposed lockdowns put the world’s delicate supply chain under extreme stress, and further disruptions from the war in Ukraine and other instances of geopolitical instability have only exacerbated that stress and hampered the supply of goods. When demand remains steady despite a reduced supply of goods, the price of those goods – and ultimately, the cost of living – rises.
What Changes is the IRS Making?
In light of current inflation levels, the IRS has released a series of adjustments for 2023. These changes may prevent people from getting pushed into higher tax brackets if their income has risen with inflation, while also limiting the amount of tax revenue the government can bring in.
These changes aren’t intended to be a tax cut or a tax increase; they’re simply shifts to account for inflation. But that doesn’t mean you won’t be impacted. Let’s take a look at some of the changes being made for the 2023 tax year.
Shifting Income Tax Brackets
Income tax brackets received a 7% bump across the board. Note that federal income tax rates remain unchanged – it’s just the brackets themselves that have shifted. Here are the new tax brackets for this year, according to the IRS3
- 35% for incomes over $231,250 $462,500 for married couples filing jointly).
- 32% for incomes over $182,100 $364,200 for married couples filing jointly).
- 24% for incomes over $95,375 $190,750 for married couples filing jointly).
- 22% for incomes over $44,725 $89,450 for married couples filing jointly).
- 12% for incomes over $11,000 $22,000 for married couples filing jointly).
- 10% for incomes of $11,000 or less $22,000 for married couples filing jointly).
Additionally, the standard deduction for individual filers has increased to $13,850 and married couples filing jointly will have a standard deduction of $27,700 (up by $900 and $1,800, respectively). Should you decide against itemizing your deductions on your tax return, you can claim the standard deduction and subtract that amount from your taxable income for the year.
Rising Retirement Contribution Limits
The IRS has also raised the annual contribution limits for retirement accounts. Taxpayers who participate in a 401(k), a 403B, most 457 plans, or the Thrift Savings Plan are able to contribute an additional $2,000 to their accounts in 2023, for a maximum contribution of $22,500. Those over the age of 50 are able to contribute up to $7,500 in additional funds as a “catch-up” contribution.
IRAs have seen their contribution limits increase by $500, which brings the annual cap to $6,500 for all IRA investors. Catch-up contributions for IRAs remain unchanged in 2023.
Social Security COLA
For the vast majority of Americans who rely on Social Security for at least a portion of their retirement income, the Social Security Administration SSA has announced that benefits will rise by 8.7% this year. As part of the largest cost-of-living adjustment COLA since 1981, recipients of Social Security will see their monthly benefits rise by more than $140 starting in January. The average monthly payout should be roughly $1,827 per person, up from $1,681 in 2022.
The SSA has also made changes to the wage base and earnings limits for workers. The maximum amount of earnings that are subject to Social Security tax has risen to $160,200, meaning the additional 6.2% Social Security tax will not be levied on any earnings that exceed $160,200. Additionally, workers who earn more than $21,240 prior to full retirement age will have their Social Security benefits reduced by $1 for every $2 they earn in excess of that amount. Workers who will reach retirement age in 2023 and earn more than $56,520 will have their benefits reduced by $1 for every $3 they earn in excess of that amount, but only until the month they turn full retirement age.
Bear in mind that these penalties only apply to the months and years prior to full retirement age, which is between 66 and 67 years old depending on when you were born. Upon reaching full retirement age, you can earn as much income as you’d like without your Social Security benefits being impacted.
Annual Gift Exclusions
Finally, one of the most potentially significant inflation-related adjustments that came in 2023 was an increase in the annual gift tax exclusion. This designates the amount you’re allowed to gift others (such as your children or grandchildren) each year without those gift counting against your $12.06 million lifetime gift tax exemption. The new annual exclusion amount is $17,000; an increase of $1,000 over 2021. For tax purposes, gifts are priced based on their fair market values, not the cash values you acquired them for. There’s no limit to the number of people you can make these annual gifts to, meaning you can give up to $17,000 to each of your children and grandchildren if you choose to.
If you’re feeling confused about any of these changes, just reach out to your financial professional for guidance. Your financial professional can help you navigate 2023 and beyond.
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This material is intended for informational/educational purposes only and should not be construed as tax, legal or investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Certain sections of this material may contain forward-looking statements. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is no guarantee of future results. Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided at these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption of any kind. Please consult with your financial professional and/or a legal or tax professional regarding your specific situation and before making any investing decisions.
All indices are unmanaged, and investors cannot actually invest directly into an index. Unlike investments, indices do not incur management fees, charges, or expenses. Past performance does not guarantee future results.
The Consumer Price Index (CPI) is a measure of inflation compiled by the US Bureau of Labor Studies.
Not associated with or endorsed by the Social Security Administration or any other government agency.
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