The IRS modifies certain rules annually to account for the effects of inflation, including individual tax brackets and the amount that can be saved in an individual retirement account (IRA). With inflation at a 40-year high, economists predict significant changes for taxpayers.
According to tax analyst Kyle Pomerleau of the American Enterprise Institute, the IRS makes these adjustments to avoid “bracket creep” caused by the rising cost of living. Without these adjustments, workers who got wage raises to keep up with inflation would be pushed into higher tax bands despite the fact that their standard of living remained same.
As a result of the hottest inflation since the early 1980s, tax experts predict that taxpayers will face some of the most significant adjustments in decades in 2018. While the IRS will likely publish these adjustments publicly in October or November, the agency uses an inflation-based calculation to calculate the new tax rates and other constraints. Pomerleau anticipates that numerous tax provisions will be increased by approximately 7% based on this formula.
Pomerleau highlighted that taxpayers might utilize this information to arrange their taxes for the upcoming year. Next year, households will determine their withholding, and firms will make investment decisions based on the amount of tax they must pay.
However, some taxpayers will rely on the new inflation-adjusted allowances to make adjustments in the coming weeks. For instance, individuals who utilize flexible spending accounts to set aside funds for medical bills must make these selections for 2023 by October or November of this year.
Workers should also consider increasing their IRA or 401(k) contributions, given that the IRS is anticipated to increase contribution limits to account for this year’s inflation, according to Eric Bronnenkant, the tax director at Betterment.
“The IRA threshold is now $6,000, so many individuals have it set up so they contribute $500 per month. If they aren’t aware of the increase and don’t make the necessary adjustments, they could be missing out on a retirement plan benefit,” he warned.
New tax brackets for the year 2023
Tax brackets set the tax rate applicable to each income segment.
Take, for example, a worker with a $40,000 taxable income this year. They will pay 10% tax on the first $10,275 of their income, followed by 12% tax on earnings between $10,276 and $40,000.
In 2023, when Pomerleau predicts that tax provisions would increase by approximately 7% each bracket, the same worker will pay 10% tax on the first $11,000 of their income, followed by 12% tax on the remainder.
Increased limits for FSAs and IRAs
Pomerleau stated that the IRS is also expected to increase contribution limits for flexible spending accounts (FSA) and IRAs.
According to his calculations, the new limit for flexible spending accounts will be $3,050, which is a 7% increase over the current year’s maximum of $2,850.
FSAs permit employees to deposit up to the maximum amount into a medical expense account. Because the money is deducted from their accounts before taxes are deducted, it provides tax savings for many employees.
The new IRA contribution maximum for 2023 is anticipated to be $6,500, according to Pomerleau. This represents an increase of approximately 8% from the $6,000 cap in 2022.
“This is likely to be the one time you’ll see a bump this large,” Pomerleau said of his forecasts. “If inflation begins to moderate, as I believe it will, we will return to more modest annual adjustments every year. This may be a one-time occurrence.