Yesterday's Price is Not Today's Price

How inflation may provide some relief for taxpayers.

Inflation. Inflation. Inflation.

You've heard a lot about inflation over the past year and have probably noticed an increase in your grocery receipts among other costs. In June 2022, year-over-year inflation hit a four decade high of 9.1%. This was driven largely by a myriad of factors, chiefly among them, was the surplus of money in the economy from Covid-19 era monetary policies, as well as a host of market factors like strong wage growth, supply chain issues, and rapid consumer demand for housing and goods. This affected the wallets of most Americans and markets across the globe. However, there is a silver lining to this past year's rapid rise of inflation, which comes in the form of the Internal Revenue Service's annual inflation adjustments. When inflation rises, the IRS adjusts the seven tax brackets, as well as certain federal tax credits and deductions, which may bring relief for taxpayers feeling the effects of increased inflation. The following adjustments take hold this year for tax returns filed in 2024.

2022 vs. 2023 Tax Brackets

Tax brackets in 2023 saw a change from last year as the IRS adjusted them to keep pace with the increased cost of living. Although the seven tax rates remained the same, the income ranges were adjusted, and you may find yourself in a lower bracket this year, assuming no significant change in your annual income. Those who earned an annual incomes of $41,776 to $44,725 as single filers in 2022 had a marginal tax rate of 22%. Those same single filers would incur a marginal tax rate of %12 this year. Looking at another example, if your annual income in 2022 was $100,000 as a single filer, you found yourself in the 24% tax bracket with $10,924 of your total income taxed in that bracket. However in 2023, only $4,624 of that income gets taxed at 24% due to the upward shift in marginal tax brackets. All in all, this would result in a decreased tax liability of $436.

Adjustments to Credits and Deductions

In 2023, the standard deduction rose $900 to $13,850 for single filers ($27,700 for those married filing jointly). Additionally, the earned income credit increased to $7,430 for qualifying taxpayers with three or more children, up from $6,935 in 2022. The adoption credit rose as well to $15,950 up from $14,890. One credit that the IRS does not index for inflation, the Child Tax Credit, remains at $2,000.

401K, IRA, AND HSA Contributions

The IRS indexes for inflation annual limits on how much you can contribute towards retirement and Health Savings Accounts (HSA). Starting this year, you can contribute up to $22,500, up $2,000 from 2022, to your 401K. If you're aged 50 or older you can contribute an additional $7,500 in "catch-up" contributions for a total of $30,000. The IRA contribution limit also increased to $6,500, however, the catch-up remains at $1,000. For HSA's, the annual limit increased to $3,850 for single filers, and $7,750. These limit increases should help taxpayers lower their tax bill if they take advantage of the deductions that accompany their contributions.

2023 Social Security Cost-of-Living Adjustment (COLA)

Social Security recipients received a record-high Cost-of-Living-Adjustment (COLA) of 8.7%. This adjustment is much needed for retirees who currently draw Social Security as their main or only source of income. The taxable income limits for Social Security are not indexed for inflation, however. Social Security gets taxed at 50% if you're a single filer with income between $25,000 and $34,000, or $32,000 to $44,000 for MFJ taxpayers. 85% of benefits get taxed when your income is more than $34,000 as a single filer, or $44,000 as MFJ. When most retirees are drawing income from retirement accounts, in addition to required minimum distributions, these benefits often become taxable to the recipient due to rising living costs, which necessitate seniors to withdraw larger sums that easily exceed the taxable income limit for Social Security benefits.

Some Final Thoughts

The good news is that inflation seems to have peaked and is showing signs of decline this year. In any event, IRS inflation adjustments affect various aspects of federal income tax, so it is important to consult with your CPA and consider what effect these changes might pose to your tax situation.

For any tax, or financial related questions, feel free to contact me at alupoli@avlcpafirm.com.