Ratcheting Up: Inflation Adjustments to Your 2023 Taxes

The IRS has raised the limits for gifting, retirement contributions, and other areas of critical importance to you. Here’s what you need to know.

The IRS recently released its inflation adjustments for 2023 related to personal income tax, retirement contributions, and estate taxes. While those won’t affect the tax return you’ll be filing in a couple of months, they will be helpful as you start your planning for the 2023 tax year.

Personal Income Tax

The standard deductions are increasing in 2023, which means a bigger tax break for you, as more of your income is automatically exempt from tax. The flipside, though, is that it’s going to be harder to itemize your deductions in 2023, which means your tax payments, mortgage interest and charitable contributions are less likely to provide you a tax benefit next year. As a result, you may want to consider a bunching strategy, where you accelerate as many deductible expenses into 2022 where it might be easier to get a tax benefit for them.

The new standard deductions for 2023:

• Married filing jointly: $27,700, up $1,800 from 2022
• Single taxpayers and married individuals filing separately: $13,850, up $900
• Heads of households: $20,800, up $1,400

Marginal tax rates, though, are unchanged, with the top tax rate remaining 37% for individual single taxpayers with incomes greater than $578,125 ($693,750 for married couples filing jointly). The inflation adjustments allow more income to be taxed at the lower rates than in 2022, however, offering a form of tax cut. For example, for 2022 that 37% rate applies to couples with income over $647,850. As a result, nearly $46,000 of income that would have been be taxed at 37% this year will be taxed at 35% in 2023. That’s a savings of over $900.

Retirement Savings Contributions

The 401(k) contribution limit is rising by $2,000, to $22,500. That’s a big jump, considering we haven’t seen an increase of more than $1,000 since the current 401(k) rules came into place in the mid-1980s. Combined with a $1,000 increase in the catch-up contribution amount for those age 50 or older, this means employees can defer up to an additional $3,000 into their retirement accounts next year.

The overall savings limit, referred to as the 415 limit, is also going up $5,000 to $66,000. This includes your own savings plus any matching or profit-sharing contributions from your employer.  Employees making after-tax contributions to a traditional 401(k) may be able to make larger contributions to those accounts next year as well.

Traditional and Roth IRA contribution limits will increase $500 to $6,500 - the first increase in that limit since 2019. Those who can qualify for a Roth contribution have also changed significantly: Married couples with income below $218,000 will be able to make a full Roth contribution next year, as will singles below $138,000. Those are up from $204,000 and $129,000, respectively, in 2022. 

The size of the phaseout ranges stayed the same, so couples with income over $228,000 (and singles over $153,000) will not be eligible to contribute to a Roth IRA next year. Barring any legislative or other changes, the Backdoor Roth IRA strategy remains an option for those over the applicable income levels. 

Estate Taxes and Gifting

The gift tax annual exclusion is increasing from $16,000 to $17,000 for 2023.  This is the first time the gift limit has increased in consecutive years. A taxpayer can gift this amount to any number of individuals each year without incurring gift tax or using any of the taxpayer’s lifetime exemption. Married couples can gift-split, allowing them to gift up to $34,000 annually to each recipient beginning in 2023.

In addition, the lifetime exemption amount increased by nearly $900,000, up to $12.92 million per individual. Those individuals who used their full exemption in recent years will now be able to make an additional tax-free gift to family members or others. Estates of decedents who die during 2023 have a basic exclusion amount of $12.92 million, up from $12.06 million for estates of decedents who died in 2022.

With the increased lifetime exemption amount, each taxpayer will be able to transfer an additional $860,000 ($1.72 million for married couples) without tax liability, beginning in 2023. (Note that the exemption is still set to sunset back by about 50% at the beginning of 2026.) If you had already maxed out your lifetime gift tax exemption, you can gift an additional amount in 2023 to help further reduce your estate.

You won’t see the full effect of these changes until you file your 2023 taxes in the spring of 2024, but they can be of tremendous help in your tax planning over the course of the year. To get out in front of your taxes for next year, reach out to our office.

The information reflected on this page are Baird expert opinions today and are subject to change. The information provided here has not taken into consideration the investment goals or needs of any specific investor and investors should not make any investment decisions based solely on this information. Past performance is not a guarantee of future results. All investments have some level of risk, and investors have different time horizons, goals and risk tolerances, so speak to your Baird Financial Advisor before taking action.