While inflation continues to be a thorn in the side of consumers, recent tax adjustments by the Internal Revenue Service (IRS) to prevent what the Tax Foundation calls “bracket creep” will provide welcomed relief in 2023. According to the Foundation, bracket creep is defined as a “push into higher tax brackets or a reduction in value from credits and deductions due to inflation.”
The upcoming IRS changes will affect more than 60 tax provisions, including income tax, capital gains tax, payroll tax, Medicare Part B premiums, etc. For this article, we will highlight the changes to 401(k) contribution limits and the standard tax deduction.
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401(k) Contributions
The deferral contribution limits for company 401(k) retirement accounts will increase by $2,000, to a max deferral amount of $22,500, in 2023. Additionally, if you are 50 years of age or older, the catch-up provision increases by $1,000 for a maximum additional deferral of $7,500 (a total of $30,000).
The increases are the largest in almost 15 years. They offer a great opportunity for consumers to not only increase retirement savings but also save additional money on taxes if in higher tax brackets.
Recommendation: Start your 2023 budgeting process now to position yourself to take advantage of these increased limits. Remember, saving early and often is the key to longer-term wealth accumulation.
Standard Deduction
The standard deduction, or the amount you can deduct against income if you do not itemize your deductions, will increase from $12,950 to $13,850 for single filers ($25,900 to $27,700 for joint filers) in 2023. The increases will further limit the number of taxpayers itemizing their deductions moving forward. This could affect certain capital allocation strategies, such as charitable gifting.
Let me explain: Currently, the law limits taxpayers to $10,000 of state/local tax deductions if itemizing deductions. Unless you have significant home mortgage interest and/or unusually high medical expenses, it is highly likely you will use the standard deduction. Additionally, if you are charitably inclined and motivated by the tax benefit of your gifts, you must account for the difference between your itemized deductions and the standard deduction or run the risk of losing any tax benefit from your gifts.
Recommendation: If you are charitably inclined and fall under the new standard deduction threshold, look to accomplish your gifting in two ways before ultimately gifting cash:
1) Look to gift low-basis stock to avoid capital gains and/or
2) If you are over 72 years of age or older, look to execute a Qualified Charitable Distribution (QCD), which allows you to gift up to $100,000 of your Required Minimum Distribution (RMD) from your pre-tax IRA and exclude this gift from your income.
* Note: Consult your financial advisor and/or accountant to determine what the right path is for you! *
