IRS new tax brackets and standard deduction could save families hundreds or even thousands of dollars. Now, for the bad news.

Why so? The large upward adjustments could create a chance to hold onto more cash when you file you 2024 tax return on next year’s income.

The payout on the standard deduction is jumping 7% from 2022 to 2023, the IRS numbers show. The standard deduction becomes $27,700 for a married couple filing jointly, an $1,800 increase from the payout slated for this year. It’s $13,850 for individuals and married couples filing separately, a $900 rise.

Likewise, the income ranges on the tax code’s seven marginal tax rates is jumping 7% for tax year 2023. The adjustments are based on averages for one of the government’s inflation gauges.

Timothy Steffen, director of tax planning at Baird Private Wealth Management, outlined how this will affect household income:

• “A married couple with taxable income of $200,000 in both 2022 and 2023 would see a reduction in their tax of nearly $900.  A couple at $500,000 of income would see their tax bill fall by over $3,700.”
• “For single taxpayers at those same income levels, their tax bills would be reduced by roughly $1,400 and $1,900, respectively.”
• “The larger standard deduction also means a bigger tax break, as more income is automatically exempt from tax.  The flip side of this, though, is that it’s going to be harder to itemize your deductions in 2023.  That means your tax payments , mortgage interest and charitable contributions are less likely to provide you a tax benefit next year.”

“Inflation adjustments to tax brackets mean that it will be harder for taxpayers to hit those higher brackets, and therefore will have more income taxed at lower rates next year,” he said.

But don’t get carried away by the tax code’s silver linings during four-decade high inflation rates, said tax attorney Adam Brewer. September’s yearly rate of inflation was 8.2%, government data showed.

The IRS adjustments are “good news for taxpayers. It’s just not enough good news, I would say. Anyone who saves money on this, you’ll get a bigger refund in 2024,” said Brewer, of AB Tax Law. But that’s cold comfort now, he added. “You can’t put a tax refund in February 2024 into the gas tank.”

The adjustments bring a lot of implications, but start with some basics.

There is a chance for tax savings

The actual rates applied to income tax brackets stay at 10%, 12%, 22%, 24%, 32% and 35%. But the nominal dollar amounts attached to each bracket are increasing.
Now suppose household income stays the same in 2022 and 2023, even as the next highest income tax bracket is farther away.

Of course, it’s a hypothetical that might not fit entirely with the tight labor market. Many employers are cutting fatter paychecks to hold onto staff. But the tax question is where increased wages land in relation to the upward adjusted tax brackets.

“The idea here is not that people will pay less tax,” said Howard Gleckman, senior fellow at the Tax Policy Center. “The idea is to keep your tax liability relatively stable” and avoid what’s called “bracket creep” where inflation pushes someone into a bigger tax bill when they don’t have the spending power to afford it.

“Taxpayers whose income remained stable are going to pay less tax on the same income because of the graduated tax scale,” Brewer said. “From a strictly tax perspective, yes, they have some tax savings. The bad news is wages stayed stable when everything else increased.”

It could push even more people to the standard deduction

Come tax time, people can choose between the standard deduction and itemized deductions. The latter includes write-offs like charitable contributions, state and local taxes, interest paid on mortgages and medical expenses.

It makes tax sense to itemize when the sum of the potential write-offs is larger than the potential standard deduction payout. Almost 14% of taxpayers itemized deductions in their 2019 tax returns and they were typically richer, according to a Tax Foundation analysis.

Speeding up expenses with a potential for an itemized deduction could be one strategy to reap the tax benefits now, he said. (The charitable contribution write-off for taxpayers who took the standard deduction expired at the end of last year.)

2023 retirement account contribution limits?

The tax year 2023 inflation adjustments announced Tuesday are one piece of the tax planning puzzle.

There’s also the question of how much the IRS is going to let savers sock away in retirement accounts like 401(k)s, IRAs and the income thresholds for possible deductions. This year, individuals can put up to $20,500 in their 401(k), an increase from $19,500. (Catch-up provisions let workers over age 50 put away another $6,500 for a total $27,000 this year.)

An IRS spokesman confirmed the agency has not yet released the 2023 contribution limit figures. Both Steffen and Gleckman said the chances are good the increases will be sizeable, in light of the inflation adjustments to other provisions.

It’s “important” but not “critical” to know future 401(k) and IRA contribution limits before the upcoming calendar year, said Julie Virta, senior financial advisor at Vanguard Personal Advisor Services. The higher focus is pouring as much as possible into current contributions, she said.

“We typically tell clients to aim to save between 12%-15% of their salary via retirement savings vehicles,” said Virta. “Between now and year-end, 401(k) investors should evaluate where their account stands, and determine if they can increase contributions. For IRAs, investors have a bit more time in that their 2022 contribution deadline is April 15 of next year.”