Inflation Causes IRS to Raise Tax Brackets, Standard Deduction by 7%

Inflation Causes IRS to Raise Tax Brackets, Standard Deduction by 7%

Agency implements adjustments to key tax code parameters for 2023, following formulas set by Congress

WASHINGTON—The Internal Revenue Service adjusted key tax code parameters for 2023 to reflect higher inflation, raising the standard deduction and the income thresholds where tax rates take effect.

The 37% top marginal tax rate will apply to individual income above $578,125 and married couples’ income above $693,750 next year, as those thresholds go up 7% from 2022 under inflation adjustments announced by the agency on Tuesday.

The standard deduction will climb to $27,700 for married couples and $13,850 for individuals, both also up about 7% from this year, letting taxpayers shield more of their earnings from income taxes. The maximum contribution to a healthcare flexible spending account will climb to $3,050 from $2,850.

Because inflation is higher than at any time in the past four decades, tax code adjustments are unusually high as well. They occur annually under formulas set by Congress and largely match analysts’ projections.

This is the largest automatic adjustment to the standard deduction since core features of the tax system were first indexed to inflation in 1985. Congress has significantly expanded the deduction beyond those automatic changes, most recently in the 2017 tax law, when it was nearly doubled.

The changes will take effect for tax year 2023 and are generally designed to prevent inflation from causing tax increases. They will show up as lower tax withholding from paychecks as soon as January and thus create larger take-home pay early next year, all else equal. Taxpayers will use the larger brackets and standard deduction to file returns in early 2024.

The adjustments announced Tuesday include the income tax brackets and dozens of other parameters. The estate and lifetime gift tax exclusion will rise to $12.92 million from $12.06 million per person. The annual gift tax exclusion—the amount any person can give to any other without affecting lifetime limits—will climb to $17,000 from $16,000.

There are six tax brackets below the top 37% bracket, with thresholds for married couples that are all double what the individual taxpayer thresholds are. The rates apply to taxable income—which is income after deductions. For individuals in 2023, the 10% bracket goes up to $11,000, the 12% bracket goes up to $44,725, the 22% bracket goes up to $95,375, the 24% bracket goes up to $182,100, the 32% bracket goes up to $231,250, and the 35% bracket goes up to the top-bracket threshold.

The IRS released tax thresholds for 2023 after inflation adjustments, including income tax brackets and other parameters.PHOTO: TING SHEN FOR THE WALL STREET JOURNAL

The IRS hasn’t released some annual adjustments yet for 2023, including income thresholds for retirement accounts and the maximum amount of allowable pretax contributions to 401(k) plans.Last week, the Social Security Administration released the 2023 inflation adjustment for the Social Security payroll tax, which will apply to earnings up to $160,200 instead of $147,000 this year.Many, but not all, dollar figures in the tax code are adjusted annually for inflation. When inflation is high, tax deductions and credits that don’t change automatically lose their value more quickly. For example, the maximum child tax credit remains at $2,000 and begins phasing out when income reaches $200,000 for individuals and $400,000 for married couples. The deduction for capital losses against ordinary income is capped at $3,000. The limit on the state and local tax deduction remains $10,000.

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