How inflation could lower your taxes
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Inflation adjustments are kind of sexy again, after years of not mattering much. The cost of living adjustments the IRS makes for 2023 are expected to be higher than they've been in decades — and could lower your taxes next year.
Why it matters: Cost of living adjustments, or COLAs, on taxes, Social Security payments and wages were barely noticed in the era before high inflation, but are now crucial for Americans coping with record price increases.
- Yes, but: Not all salaries get COLA'd, and many taxes and deductions aren’t inflation adjusted. The tax code is a bit of a mishmash.
- "These inflation adjustments can hardly be called a silver lining, as Americans are paying more for everything from housing to food and energy," the WSJ pointed out in a story about the changes.
What's happening: The IRS adjusts tax brackets every year to ward off "bracket creep" — when your salary rises to keep up with inflation, propelling you into a higher tax bracket.
- This is easy to understand if you go back and look at salaries from decades ago. Say the IRS tax brackets were still set at a 1980 level, then someone earning $34,000 a year — a tidy sum at the time — would face a 49% tax rate. That would be considered extremely regressive in 2022.
- Congress codified the annual inflation adjustments as part of the Reagan tax cuts in 1981; they went into effect in 1985. Before then, a period when inflation was high, brackets weren't adjusted.
- It was "a big issue," at the time, Kyle Pomerleau, a senior fellow at the American Enterprise Institute, tells Axios.
State of play: Likely at the end of October or in early November, the IRS will announce the 2023 adjustments. But Pomerleau already put out his estimates:
- The upper limits on tax brackets should go up by about 7%, he estimates. For example, in 2022, the 24% tax bracket maxed out at $89,075 — but in 2023, that should adjust to $95,375, he estimates.
- Separately, the IRS will also inflation adjust the withholding tables used by employers to calculate payroll deductions.
The impact: Taken together, these changes could mean more take-home pay even if your salary doesn't change from December 2022 to January 2023, (assuming no other changes to withholding).
Other inflation adjustments of note: The standard deduction is expected to rise to $13,850 for single tax filers, up from $12,950, according to Pomerleau's math. The gift tax exemption moves to $17,000 from $16,000. The amount you can put into your retirement accounts will also increase.
- Not adjusted: The $10,000 cap on the popular state and local tax deduction won't change. Neither will the child tax credit. If Congress doesn't do anything, inflation will slowly erode away those tax breaks.
What to watch: The inflation adjustment on Social Security for next year is expected to be 8.7% — the highest since 1981, according to an estimate from the Senior Citizens League.
- That adjustment is expected to be announced next week after the September consumer price index numbers come out.
