IRS changed its tax brackets for 2023. Here's what it means for your taxes.
Americans could save on taxes this year because of historically large inflation adjustments set by the IRS.
The agency adjusted many of its 2023 tax rules to help taxpayers avoid "bracket creep." That's when workers get pushed into higher tax brackets due to the impact of cost-of-living adjustments to offset inflation, despite their standard of living not having changed. On average, the IRS pushed up each provision by about 7% for 2023.
The changes could mean tax savings for some taxpayers, providing some relief at a time when Americans are still struggling with high inflation that's eating away at their purchasing power. For instance, some taxpayers could fall into lower tax brackets as a result of the changes, while those who use the standard deduction — relied on by 86% of taxpayers — will be able to deduct more of their income from taxation.
For instance, a married couple earning $200,000 in both 2022 and 2023 would save $900 in taxes this year because more of their income would be taxed at a lower rate, according to Tim Steffen, director of tax planning with Baird.
That could be a welcome change given that this year's tax returns (for the 2022 tax year) are expected to deliver a "tax refund shock" to many Americans due to the expiration of pandemic tax credits. As a result, refunds could be significantly smaller in 2023 compared with a year earlier.
Still, the tax bracket changes may not save money for everyone, especially those who saw their incomes rise by 7% or more, noted the Tax Policy Center, a think tank that focuses on taxes.
"It's just keeping them from facing higher taxes if their inflation-adjusted incomes (also known as real incomes) rise by 7%," senior fellow Robert McClelland wrote in a blog post.
Taxpayers will file their 2023 tax returns in early 2024.
Standard deduction
The standard deduction is used by people who don't itemize their taxes, and it reduces the amount of income you must pay taxes on.
- For married couples filing jointly, the standard deduction is $27,700 for 2023, up from $25,900 in the 2022 tax year. That's an increase of $1,800, or a 7% bump.
- For single taxpayers and married individuals filing separately, the standard deduction is set at $13,850 in 2023, compared with $12,950 last year. That's an increase of about 6.9%.
- Heads of households' standard deduction in 2023 jumps to $20,800 from $19,400 in 2022. That's an increase of 7.2%.
"The flip side of this, though, is that it's going to be harder to itemize your deductions in 2023," Steffen said. "That means your tax payments, mortgage interest and charitable contributions are less likely to provide you a tax benefit next year."
Most taxpayers take the standard deduction, especially after the 2017 Tax Cuts and Jobs Act enacted a more generous deduction. Only about 14% of taxpayers itemized their taxes after the passage of the tax overhaul, or a 17 percentage-point drop compared with prior to the law, according to the Tax Foundation.
Tax brackets
The IRS boosted tax brackets by about 7% for each type of tax filer for 2023, such as those filing separately or as married couples. The top marginal rate, or the highest tax rate based on income, remains 37% for individual single taxpayers with incomes above $578,125 or for married couples with income higher than $693,750.
The lowest rate remains 10%, which impacts individuals with incomes of $11,000 or less and married couples earning $22,000 or less. Below are charts with the new tax brackets.
Tax brackets show the percentage you'll pay in taxes on each portion of your income. A common misconception is that the highest rate is what you'll pay on all of your income, but that is incorrect.
Take a single taxpayer who earns $110,000. In 2023, she will take a standard deduction of $13,850, reducing her taxable income to $96,150. This year, she'll pay:
- 10% tax on her first $11,000 of income, or $1,100 in taxes
- 12% tax on income from $11,000 to $44,735, or $4,048
- 22% tax on the portion of income from $44,735 up to $95,375, or $11,140
- 24% tax on the portion of her income from $95,374 to her limit of taxable income, $96,150, or $775
Together, she'll pay the IRS $17,063 in taxes, which amounts to an effective tax rate of 17.7% on her taxable income.
Earned Income Tax Credit
The maximum amount for households who claim the Earned Income Tax Credit will be $7,430 for those who have at least three children, compared with $6,935 in the current tax year, the IRS said.
Capital gains tax brackets
Capital gains — the profit from investments or other assets — are taxed using different brackets and rates than earned income. The income thresholds for capital gains taxes were also adjusted due to inflation for 2023.
For instance, in 2022 single taxpayers who earned below $41,675 were not required to pay capital gains taxes on their investments. In 2023, that threshold is rising by about 7% to $44,625. Single taxpayers who earn above that amount are subject to a 15% capital gains tax, while those who earn above $492,300 in 2023 will be subject to the top capital gains rate of 20%.
Bigger gift exclusion
People can also give up to $17,000 in gifts in 2023 without paying taxes on the money, up from $16,000 in the prior year.
Estate tax limit
The estates of wealthy Americans will also get a bigger break in 2023. The IRS will exempt up to $12.92 million from the estate tax in the current tax year, up from $12.06 million for people who died in 2022 — an increase of 7.1%.
Flexible spending accounts
Flexible spending accounts allow workers to put money, up to the limit allowed by the IRS, in an account that can be used to pay for medical expenses. Because the funds are taken from their accounts on a pre-tax basis, it offers tax savings for many workers.
The new IRS limit for FSA contributions for 2023 is $3,050, an increase of about 7% from the current tax year's threshold of $2,850.
However, most employees set their FSA limits in the fall, which means that workers would have had to set the higher amount late last year to take advantage of the higher 2023 limit.