Inflation drives up the price of everything from gas to groceries, but IRS inflation adjustments mean that the impact of inflation on 2022 and 2023 tax brackets and some tax credits isn't all bad.
Inflation. Inflation. Inflation. You're hearing and thinking about it a lot lately – especially when you go to the store for “just a few items” and see a sky-high amount on your receipt. That's because in the last year or so, inflation rates in the U.S. have hovered around a 40-year high. So, that means that two years ago, you probably paid around $1.34 for a dozen eggs, while now, a dozen eggs might cost $3.59 or more. (Although with recent soaring egg prices, you're probably paying over $4.00 for a dozen eggs.) Thankfully however, with federal taxes, inflation might not have the same harsh impact because the IRS makes annual inflation adjustments to more than sixty tax provisions.
When inflation is high, IRS inflation adjustments can increase the value of those federal tax credits and deductions. The inflation adjustments that apply for the 2022 tax year (and that have been released for 2023), may not create a huge change in your tax bill or tax refund—if you're expecting one. But it's still important to know which key tax deductions and credits are adjusted for inflation.
That information might help your tax planning and help you save some money when it's time to file your 2022 tax return.
Tax Brackets 2022 and Inflation
To understand the relationship between inflation and federal income tax brackets, it is helpful to appreciate what inflation is and what has caused inflation to be high.
Inflation is essentially an increase in the price of goods and services, coupled with a reduction in the value of money. It's measured by an index (typically the consumer price index) that compares the prices of various goods over time (take for example, the cost of eggs mentioned in the introduction).
While inflation is driven by varied market forces, the record high inflation in 2022 has been caused by factors that converged during and after the COVID-19 pandemic. For example, soaring consumer demand for goods and real estate, supply chain issues and shortages, strong job growth, and increased wages.
Even with high inflation though, the seven federal income tax rates don't change from year to year. They are: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. But the federal income tax brackets tied to those rates are inflation adjusted on a yearly basis.
So, for the 2023 tax year, you may feel like you received a bit of tax break even if your taxable income essentially stays the same as it was in 2022. That's because you could end up in a lower tax bracket with a lower tax rate that goes with it.
For the 2022 tax year (Tax Day is April 18, 2023), for example, single filers with $41,776 to $89,075 of taxable income are in the 22% federal income tax bracket. (For 2023, that bracket will apply to single filers with taxable income from $44,725 to $95,375.)
So, if you have $42,000 of taxable income in both 2022, and 2023, you will move from the 22% federal tax bracket to the 12% bracket when you file your 2023 tax return. Because the tax brackets are inflation adjusted, the 12% tax bracket ends up applying to single filers making $11,000 to $44,725 for 2023.
Since relatively high inflation has hung on for a while, the inflation adjusted income tax brackets for 2023 are more favorable for some people than the 2022 amounts. Also, you might be able to avoid so-called “bracket creep,” (i.e., when a person's income basically stays the same, but they still end up in a higher tax bracket.)
Standard Deductions 2023
Standard deductions are also adjusted to account for inflation. Those changes might help reduce your tax bill if you don't claim itemized deductions.
For 2022, the IRS increased the standard deduction for different filing statuses (e.g., single, head of household, married filing jointly, etc.) by a little more than 3%. That's significantly higher than the rate of increase for the 2021 standard deduction amounts.
So, for the 2022 tax year, the standard deduction is $12,950 if you are single. In 2021, it was $450 less. For a married couple filing jointly, the 2021 standard deduction was $25,100. In 2022, it increased by $800 to $25,900.
The standard deduction for 2023 was released by the IRS on October 18. For the 2023 tax year the standard deduction is $13,850 if you're single, so that's an increase of $900 from 2022. For a married couple filing jointly, the 2023 standard deduction is increasing by $1,800, to $27,700.
401(k) Contribution and IRA Contribution
Limits on how much you can contribute to your 401(k) are also indexed for inflation. This means that if you contribute to your workplace retirement account, which already reduces your taxable income, you may be able to contribute more each year—particularly when inflation is high.
The 2022 contribution limit for 401(k) plans is $20,500 – up $1,000 from the limit that applied the previous two tax years. If you are at least 50 years old, you can contribute an additional $6,500 in "catch-up" contributions in 2022, for a total of $27,000.
If you're wondering about individual retirement accounts, IRA contribution limits unfortunately didn't increase for this year. Total contributions to traditional or Roth IRAs remain limited to $6,000 in 2022. If you're age 50 or older, the maximum “catch up” contribution is $1,000, for an annual total of $7,000.
There is some good news for IRAs for the 2022 tax year, however. The income ceilings for Roth IRA contributions were adjusted up because of inflation. As a result, the 2022 income limit for making Roth IRA contributions is now $214,000 for joint filers and $144,000 for single filers (compared to $208,000 and $140,000, respectively, for 2021).
401(k) Contribution Limits 2023: On October 21, the IRS announced significant inflation adjustments for the 2023 401(k) contribution limits, and the IRA contribution limit for 2023. The 401(k) contribution limits for 2023 increased to $22,500, while the IRA limit for 2023 also increased—to $6,500.
The 2023 401(k) contribution limit, which is $2,000 more than it was for 2022, applies to employees who participate in not just 401(k) plans, but also in most 457 plans and the federal government Thrift Savings Plan. The catch-up contribution limit for those age 50 or older participating in those plans is also up in 2023, i.e., from $6,500 in 2022 to $7,500.
The IRA contribution limit for 2023 is also up by $500 from 2022. So, for 2023, you can contribute up to $6,500. If you're age 50 or older, the IRA catch up contribution limit is not adjusted for inflation though, so it will stay at $1,000 for 2023.
Capital Gains and Depreciation
In addition to high prices for common goods like food and gas, inflation also raises the cost of many capital assets likes houses and cars. And because the IRS doesn't index capital gains for inflation, when inflation is high, capital losses are essentially multiplied.
When it comes to paying taxes on capital gains, the income thresholds for the long-term capital gains tax rates are adjusted each year for inflation. As with ordinary income tax rates, if your taxable income essentially stays the same, you may be able to avoid bracket creep by staying out of the 20% capital gains tax bracket.
The value of depreciation deductions for certain assets can also decline in periods of high inflation. But for the 2022 tax year, the IRS raised depreciation limits for passenger cars, for example.
First year depreciation increased last month to $19,200 for the first tax year the vehicle is in use. That is up $1,000 from 2021. Depreciation limits for succeeding years of passenger vehicle use also increased slightly from last year.
HSA Contribution and 2023 HSA
If you are enrolled in high deductible health plan, a health savings account or HSA, offers a tax-free way to pay for qualified health expenses and to potentially grow your retirement savings. An additional positive is that the tax-deductible amount that you can contribute to your HSA is adjusted annually for inflation. For 2022, the contribution limit for individuals is $3,650. For families, the limit is $7,300.
If you are 55 years or older, you can advantage of the “catch-up” contribution of $1,000. In that case, the 2022 contribution limit totals are $4,650 for individual coverage and $8,300 for family coverage.
Because of inflation, the HSA contribution limits for 2023 will be adjusted upward by $200 for individuals and $450 for families. For those of you who are 55 or older, the catch-up contribution will stay at $1,000. So, the 2023 HSA contribution limit will be up to $3,850 for individuals and up to $7,750 for family coverage.
Flexible Spending Accounts: Health FSA annual contribution limits are also inflation adjusted. Those adjustments can help stretch the value of the money you use to pay for qualified out-of-pocket health expenses. The FSA contribution limit increased in 2022 to $2,850. For 2023, that limit is up about 7%, to $3,050.
Social Security COLA 2023
Income limits for taxing Social Security benefits are not adjusted for inflation. However, the Social Security retirement benefits you receive do get a cost-of-living adjustment (COLA) that can increase your income.
For 2022, that adjustment was 5.9%, which was a record high. But the Social Security COLA for 2023 is higher—i.e., 8.7%. That's important because even though this represents a substantial raise for many Social Security recipients, depending on the amount of your other taxable income, up to 85% of your Social Security may be taxable.
Are Social Security Benefits Taxable? Again, the major increase in the 2023 Social Security COLA could impact your taxes depending on the circumstances surrounding your other taxable income. So, you might have to pay taxes on some portion of your Social Security benefit.
The Social Security Benefit Statement (Form SSA-1099) that you receive from the federal government shows the amount of benefits you received in the previous year, which might help you to determine whether your benefits are subject to tax.
Child Credit 2022, Earned Income Tax Credit, and Adoption Credit
Numerous other tax provisions can be impacted by inflation depending upon whether they're inflation adjusted. A few of those are highlighted below.
- The Child Tax Credit: The $2,000 Child Tax Credit is not currently adjusted for inflation, but the refundable portion of the credit is. For 2022, the IRS increased that by $100 to $1,500. For 2023, the refundable portion of the child tax credit goes up by $1,000, to $1,600.
- The Adoption Credit: If you're adopting a child, the IRS slightly increased the 2022 maximum adoption tax credit for adoption expenses from $14,440 to $14,890. For 2023, the maximum credit for allowable adoption expenses goes up to $15,950. So that's a $1,060 increase from 2022.
- Earned Income Tax Credit: The EITC is designed to reduce the tax liability for low-to-moderate-income families. The maximum credit amounts, phase-out ranges, and investment income limits are all adjusted annually to account for inflation. But there are many different EITC amounts for different categories of taxpayers.
For example, the earned income tax credit for 2023 for eligible filers with no children, is $560. The maximum earned income tax credit for eligible taxpayers with one child is $3,995, $6,604 for filers with two children, and $7,430 for filers with three or more children.
If you think you qualify for the EITC, be careful when you calculate the amount, or consult a tax professional if you're not sure.
Impact of Inflation: What can you do?
This is not tax advice and should not be construed as such. Please seek professional tax services for more information and advice that will apply to your specific tax situation.
Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual.