While you might dread filing your federal tax return, your 2022 return is likely to be favorably impacted by some significant, inflation-driven adjustments. Remember that it is due on or before April 18, 2023.
Why Do Inflation Adjustments Matter?
Each year, the Internal Revenue Service (IRS) implements inflation adjustments that impact over 60 federal tax provisions, which include exemptions, exclusions, deductions and credits. Ultimately, these provisions impact the amount of your tax bill.
As a result, it is important to file your taxes in a strategic manner. A well-informed and comprehensive approach is the only way to ensure that you claim the most economically beneficial combination of available provisions. Given the complexity of the Internal Revenue Code, this often entails enlisting the help of a tax professional.
Why Do Inflation Adjustments Exist?
The IRS utilizes inflation adjustments to account for widespread increases in income levels and the prices of goods and services in our economy — as measured by the Consumer Price Index (CPI). As inflation drives up your income, the IRS endeavors to tax it in an economically consistent manner from one year to the next. At the same time, the IRS strives to grant you the ability to claim exemptions, deductions and credits in an economically consistent way over time.
In aggregate, the inflation adjustments should not be viewed as either punitive or beneficial. Rather, they are designed to keep the tax code on par with developments in our economy.
That said, be sure to pay attention to inflation adjustments — learn about five prominent inflation adjustments that could impact your 2023 tax bill.
1. Tax Brackets
The inflation adjustment that is bound to impact the greatest number of tax filers relates to the tax brackets, which are ranges of income associated with the various tax rates embedded in the United States’ progressive income tax system.
Broadly speaking, for 2022, the tax brackets have increased by about 3.0% for all filing statuses. This is significantly higher than the roughly 1.0% increase enacted for 2021.
2. Standard Deduction
Another inflation adjustment that will affect many tax filers pertains to the standard deduction. According to recent data compiled by the IRS, this deduction is claimed by nearly 90% of personal income tax filers. The rest itemize their deductions.
For 2022, the standard deduction for single taxpayers and married individuals filing separately is $12,950, up $400 from 2021. This reflects a 3.2% increase.
The inflation adjustment for head of household filers is $19,400, up $600 from 2021. The adjustment for married couples filing jointly is $25,900, up $800 from 2021. Both statuses reflect a year-over-year increase of 3.2%.
3. Contribution Limits for Employer-Sponsored Retirement Plans
The third inflation adjustment on the list pertains to the annual contribution limits for employer-sponsored retirement plans, including 401(k), 403(b), most 457 plans and the federal government’s Thrift Savings Plan. For 2022, the contribution limit for employees is $20,500 ($27,000 for individuals age 50 and over). This is a $1,000 increase over the 2021 limit, which is $19,500 ($26,000 for individuals age 50 and over).
For traditional-style plans, the $1,000 bump gives you a meaningful opportunity to shelter more of your income from taxation, while magnifying the long-term growth potential of your retirement portfolio. Roth-style plan contributions are not deductible. Nevertheless, like traditional plans, the more you save, the greater your long-term growth potential.
Incidentally, the limits specified above relate to employee contributions. The IRS allows employers to contribute additional amounts to their employees’ plans. For 2022, the aggregate contribution limit for an employer-sponsored plan is $61,000 ($67,500 for individuals age 50 and over). For 2021, the aggregate contribution limit is $58,000 ($64,500 for individuals age 50 and over).
4. Income Phase-Out Ranges for IRAs
Unlike employer-sponsored retirement plans, the 2022 contribution limits for traditional and Roth individual retirement accounts (IRAs) remain the same as 2021. The maximum permissible contribution is $6,000 ($7,000 for individuals age 50 and over). This is an aggregate limit and applies to all IRAs held.
While contribution limits remain unchanged, the 2022 income phase-out ranges for IRAs were adjusted for inflation.
For example, the traditional IRA income phase-out range for married couples filing jointly for 2022, if the spouse making the IRA contribution is covered by an employer-sponsored retirement plan, is now $109,000 to $129,000. For an IRA contributor who is not covered by an employer-sponsored retirement plan and is married to someone who is covered, the phase-out range is $204,000 to $214,000 for 2022, up from $198,000 to $208,000 for 2021.
For single and head of household taxpayers covered by a workplace retirement plan, the phase-out range is $68,000 to $78,000, up from $66,000 to $76,000 for 2021. For a married individual filing a separate return who is covered by an employer-sponsored retirement plan, the phase-out range remains $0 to $10,000.
The Roth IRA income phase-out range for single and head of household taxpayers for 2022 is $129,000 to $144,000, up from $125,000 to $140,000 for 2021. For married couples filing jointly, the income phase-out range is $204,000 to $214,000, up from $198,000 to $208,000 for 2021. For married individuals filing separately, the phase-out range remains $0 to $10,000.
5. Earned Income Tax Credit
A final inflation adjustment worthy of noting pertains to the earned income tax credit (EITC), a refundable tax credit for workers earning low to moderate income. For 2022, the maximum EITC is $6,935, up from a maximum of $6,728 for 2021. However, the actual claimable amount depends on filing status, income and the number of qualifying children you have.
While this credit is not available to everyone, it is common. If you meet the criteria, it’s worth pursuing, especially given the 3.1% top-end increase enacted for 2022.
2023 Inflation Adjustments (for 2023 Tax Returns Filed in 2024)
The inflation adjustments for the 2023 tax year, which were enacted on October 18, 2022, are over twice as large as those for 2022. This is a direct result of the elevated CPI readings reported throughout 2022 — a byproduct of COVID-induced supply chain disruptions, strong consumer demand and upward pressure on wages in many sectors of the U.S. economy.
To illustrate, let’s focus on the standard deduction. This is just one aspect of the tax code, but when evaluated year-over-year, it offers the most holistic measure of the IRS’ view on inflation.
For 2023, the standard deduction for single taxpayers and married individuals filing separately is $13,850, up $900 from 2022. This reflects a 6.9% increase.
The inflation adjustment for head of household filers is $20,800, up $1,800 from 2022. The adjustment for married couples filing jointly is $27,700, up $1,800 from 2022. Both statuses reflect an approximate year-over-year increase of 7.0%.