The IRS announces new tax bracket adjustments for 2023

The IRS announces new tax bracket adjustments for 2023

On Tuesday, the IRS announced its annual adjustments to the standard deduction and tax brackets for the 2023 tax year. It's a significant increase compared to 2022. This is in response to persistent inflation, which erodes purchasing power even as salaries increase for some workers.

As with all taxes, this can raise some questions. Below, we will provide answers.

What is the new standard deduction for 2023?

The new standard deductions for personal income taxes apply as follows:

Individuals: $13,850 in 2023, an increase of $900

Head of household: $20,800, an increase of $1,400

Filing jointly for spouses: $27,700, an increase of $1,800

What are the new tax brackets for 2023?

The new tax brackets for personal income taxes apply as follows:

10%: All income less than $11,000 single / $22,000 married

12%: $11,000 single / $22,000 married, an increase of $725 / $1,450

22%: Single $44,725 / Married $89,450, an increase of $2,950 / $5,900

24%: $95,375 single / $190,750 married, an increase of $6,300 / $12,600

32%: Single $182,100 / Married $364,200, an increase of $12,050 / $24,100

35%: Single $231,250 / Married $462,500, an increase of $15,300 / $30,600

37%: All income over $578,125 single / $693,750 married, an increase of $38,225 / $45,900

Capital gains taxes have also been revised. The capital gains brackets for 2023 are:

0%: All earnings less than $44,625 single / $89,250 married

15%: $44,625 / $89,250 married, up $2,950 / $5,900 married

20%: Single $492,300 / Married $553,850, an increase of $32,550 / $36,650

Does the IRS usually do this?

Yes.

The IRS automatically adjusts the income tax brackets and standard deduction yearly in response to annual inflation. If it didn't, Americans would pay 30% on every dollar over $6,000. Adjusted for inflation, that would amount to a 30% tax bracket on all income over $75,800, indicating how little Americans pay taxes compared to decades past.

What is noteworthy in 2023 is the scale of these modifications. Since the 1980s, inflation in the United States has remained around the Federal Reserve's 2% target rate, fluctuating between 0% and 4% most years. This has resulted in relatively minor annual tax adjustments.

The high inflation of 2022 caused huge hits in this otherwise routine exercise, with most adjustments between 6.5% and 8%. For example, between 2021 and 2022, the IRS adjusted the individual 12% bracket by $325, an increase of approximately 3.2%. For the 2023 tax year, the IRS changed the same 12% bracket by $725, an increase of 6.5%.

What is the impact of the new tax brackets?

Any upward adjustment to the standard deduction or tax brackets is an effective income tax reduction. This means that taxes apply to less income and that you pay less on taxable income.

The question is whether any taxpayer will end up with more purchasing power. The IRS does not adjust its rates to give people a tax break but rather to reflect the new value of money based on inflation/deflation cycles. If prices go up 10%, but you keep 7% more on your taxes, then as a consumer, you're still effectively less wealthy than when you started.

What makes this even more confusing is the degree to which sector-specific and region-specific inflation have clouded the economic picture; contrary to public reports, prices have leveled off in many areas but have risen in a few others. The result is that some taxpayers will get richer from these price changes based on their spending patterns.

For example, if you own your own home, you are insulated from the housing costs causing so much of the current inflation. With gas prices back to normal and food and consumer goods inflation flat, you could get richer from these slide changes. By contrast, average rents have increased between 12.5% and 16% since 2021. If you're renting an apartment, particularly in a city, these tax changes will cover only half of the increase in the cost of living.

How does this tax change apply?

This applies to all US income taxpayers. If you file and pay income taxes with the IRS in 2023, you will do so with the new brackets.

What income does that affect?

The new tax brackets will apply to all earnings starting January 1, 2023. They don't apply retroactively, so you can't use the new standard deduction or tax rates to income on or before December 31, 2022.

Can I apply this to current earnings?

It depends on the above; no, You can apply the new tax brackets to any income you earn on or before December 31, 2022. In IRS-talk, if you fire a tax event in 2022, the existing tax brackets will apply, not the new brackets.

But you can apply the new tax brackets if you can

Defer earnings until 2023. The key is, in this term, "tax event." This is a technical term for the IRS, which means any event that makes you owe taxes on income, earnings, or other wealth. It means different things under different circumstances, but for individuals, a taxing event usually occurs when you acquire new wealth. For example, receiving your paycheck is considered a taxable event. The same goes for when you collect profits from the sale of shares or receive payment after billing a customer.

Business Earnings: It is important to note that businesses can use two different bookkeeping methods. One considers it a tax event when one owes money. The other believes it is a tax event when you collect that money. Make sure you understand the method you are using and apply it consistently.

The common theme is that, in most cases, you trigger a tax event when the new wealth is received, not when it is due. In other words, you pay 2022 tax rates on all the money you raised in 2022. And you will pay 2023 tax rates on all the money you raise in 2023.

If you can defer income or dividends until 2023, you may be able to take advantage of the new rates. For example, some employers will allow you to defer your salary. Employees who do so can push their earnings into the new tax year. Self-employed individuals can wait for billing to customers until January 1, 2023, and collect under the new categories instead of the old ones. Selling investment assets is more complicated since price changes may avoid any tax gains, but the same rules apply for marketing in 2022 versus 2023.

It is important to note that this is theoretical and should never be considered individual tax planning advice. The rules for your situation may vary, as tax laws are very specific and can depend on your employer's bookkeeping method. Consult an accountant or financial advisor before making any plans.

Do I have to do anything?

No. Despite the large size, this is a standard change. It does not affect your rights or responsibilities differently from any other tax year. You'll pay your taxes as usual and apply for the new numbers as appropriate.

Tips for taxpayers

Tax brackets may be the most misunderstood part of all tax laws. Just because you're in the 22% bracket doesn't mean you pay 22% of your income to the IRS. Here's why.

Tax planning can be complex, and you should go with others. With SmartAsset's matching tool, you can find a financial advisor near you to help you plan your taxes to maximize your deductions and compliance in one go.