As you probably know, the federal income tax rate brackets, and many other federal tax parameters, are indexed for inflation using a factor based on the monthly average of changes in the chained Consumer Price Index, or chained CPI. Due to the way they are calculated, upticks in the chained CPI numbers during inflationary times, like now, are a bit lower than upticks in the regular CPI numbers that you read about in the media. But the differences are relatively trivial. To keep things simple in this column, let’s just call the chained CPI the CPI and go with it. OK? Onward.
As you may have noticed, inflation has been surging this year, and that will be reflected in the monthly CPI numbers that will be used to calculate the inflation adjustment factor for your 2023 federal income tax brackets. Those brackets, and other inflation-adjusted federal tax parameters, will probably be announced in November. They will be based on the monthly average of CPI changes during the federal government’s fiscal year that began in October of last year and will end in September of this year.
Impact of inflation on 2022 and 2023 tax brackets
For the 12 months that were used to calculate the inflation adjustment factor for the 2022 tax year, inflation was mild in the first half and started running hotter only in the second half. As a result, the inflation adjustment factor for 2022 was only about 3.1%. For example, the beginning of the 24% rate bracket for a married joint-filing couple is $ 178,150 of taxable income for 2022. That’s 3.13% higher than the corresponding number of $ 172,750 for 2021. Basically, ho hum.
That was then. This is now. You’ll not be surprised to hear that there will be a much-higher inflation adjustment factor for the 2023 tax year. According to my calculations, we are headed for about a 7% inflation adjustment. Maybe more depending on how inflation pans out through September. For the eight months taken into account so far, we are looking at a factor of about 7.1%. Let’s assume that the inflation adjustment factor for the 2023 tax year will be 7%.
How would that affect your personal federal income tax situation? Please keep reading.
Inflation-adjusted guesstimates for your 2023 tax year
With an assumed 7% inflation adjustment factor, all the federal income tax bracket boundaries would increase by about 7%. It won’t be exactly 7%, because federal tax parameters are adjusted in certain dollar increments with rounding. For example, the tax bracket numbers are adjusted in $ 25 increments, but the standard deduction numbers are adjusted in $ 50 increments. Annual contribution limits for your 401(k) account are adjusted in $ 500 increments. The unified federal estate and gift tax exemption numbers are adjusted in $ 10,000 increments.
Moving right along, an assumed 7% inflation adjustment factor would increase the 2023 tax rate brackets as follows:
|Joint Filers||Singles||Heads of Household|
|End of the 10% bracket||$ 22,000||$ 11,000||$ 15,650|
|Beginning of 12% bracket||$ 22,001||$ 11,001||$ 15,651|
|Beginning of 22% bracket||$ 89,401||$ 44,701||$ 59,800|
|Beginning of 24% bracket||$ 190,601||$ 95,301||$ 95,301|
|Beginning of 32% bracket||$ 363,901||$ 181,951||$ 181,951|
|Beginning of 35% bracket||$ 462,201||$ 231,101||$ 231,101|
|Beginning of 37% bracket||$ 693,201||$ 577,701||$ 577,701|
Impact: Other things being equal, you could have 7% more taxable income next year and have the same federal income tax bill as this year. Nice. While almost nobody likes inflation, it’s an ill wind that blows no good, as the saying goes.
An assumed 7% inflation adjustment factor would increase the 2023 standard deduction amounts as follows:
|Joint Filers||Singles||Heads of Households|
|$ 27,700||$ 13,850||$ 20,750|
Impact: If you don’t itemize deductions, your standard deduction would shelter 7% more income from the federal income tax next year. Good.
An assumed 7% inflation adjustment factor will increase the top of the 0% federal income tax bracket for 2023 long-term capital gains and qualified dividends as follows:
|$ 89,200||$ 45,600||$ 59,700|
Impact: Other things being equal, you could have 7% more in federal-income-tax-free long-term capital gains and dividends next year. Good.
An assumed 7% inflation adjustment factor would increase the beginning of the 20% maximum federal income tax bracket for 2023 long-term capital gains and qualified dividends as follows:
|$ 553,401||$ 491,901||$ 522,701|
Impact: You would have a better chance of avoiding the 20% maximum rate next year. Good.
And there’s more
An assumed 7% inflation adjustment factor would increase the maximum 401(k) contribution from the current $ 20,500 to $ 21,950 next year. Good.
An assumed 7% inflation adjustment factor would also increase lots of other federal tax parameters, such as the 2023 phase-out ranges for deductible contributions to traditional IRAs, the 2023 phase-out ranges for contributions to Roth IRAs, the 2023 phase-out ranges for the qualified business income (QBI) deduction for small business owners, and the unified federal gift and estate tax exemption for you 17 dear readers who will be affected by that.
It’s all good — as long as you would prefer to pay less taxes next year rather than more.
Can you take this “good news” to the bank?
Uh, no. The preceding taxpayer-friendly guesstimates assume there will be no new legislation that affects your 2023 federal tax position. However, there are rumblings from D.C. that some Democrats, including West Virginia Senator Joe Manchin, are discussing a scaled-down version of President Biden’s ill-fated Build Back Better (BBB) bill. A resurrected BBB could include federal tax increases — such as jacking up the top income tax rate from the current 37% to 39.6%, starting next year. There could be other unfavorable changes for certain taxpayers if anything gets through our beloved Congress.
The bottom line
Don’t get cocky. Stay tuned for possible negative developments. Needless to say, we will keep you informed.