Inflation means the IRS can change your tax bracket soon. Here’s what you need to know.

Each year, the IRS adjusts several provisions to account for the impact of inflation, ranging from individual tax brackets to the amount you can save in your individual retirement account, or IRA. With inflation nearing its highest level in 40 years, experts say some major changes are likely within the reach of taxpayers.

Kyle Pomerleau of the American Enterprise Institute, a tax expert, noted that the IRS is making these changes to avoid “bracket creep” from rising costs of living. Without such adjustments, workers who received wage increases to keep up with inflation would bump into higher tax brackets, even though their standard of living remained the same.

This year, taxpayers could see some of the biggest changes in decades due to Inflation hotter Since the early 1980s, tax experts say. While the IRS is likely to officially announce these changes in October or November, the tax agency relies on a formula, based on inflation data, to calculate the new tax brackets and other limits. Based on that formula, Pomerlo Forecasting That many tax provisions will be revised upwards by about 7%.

“This is something taxpayers can use to plan their taxes for the next year,” Pomerleau noted. “So next year taxpayers will determine their deduction, companies will make investment decisions, and that will depend on how much tax they have to pay.”

However, some taxpayers will rely on the new inflation-adjusted provisions to make changes in the next several weeks. For example, people who use flexible spending accounts to set aside money for medical expenses will need to make these 2023 decisions in October or November of this year during open enrollment.

Taxpayers are also likely to see a higher standard deduction in 2023, which could help lower their taxes. The standard deduction is the amount a taxpayer can use to reduce their taxable income, so increasing this provision can conversely reduce the amount of income a worker earns that will be taxed in the next year.

Workers should also consider whether they should invest more in IRAs or 401(k) accounts, since the IRS will likely also make contribution limits more generous to reflect inflation this year, noted Eric Bronenkant, head of tax at Betterment Financials. . .

“The minimum IRA now is $6000, so a lot of people set it up, so they put in $500 a month, and if they don’t think about it, that’s an increase and they don’t adjust to the rise, they may be missing out on retirement plan benefits.”

New tax brackets for 2023

tax brackets Determine the tax rate you will pay on each portion of your income.

For example, take one worker whose taxable income this year is $40,000. They will pay 10% in tax on their first $10,275, then 12% on their earnings between $10,276 and $40,000.

In 2023, when Pomerleau estimates that tax provisions will rise by 7% per bracket, the same worker will pay 10% tax on their first $11,000 of earnings, and then a 12% tax after that.

Higher limits for FSAs and IRAs

Pomerleau said the IRS is also likely to strengthen its Flexible Spending Account (FSA) limits and IRA contribution limits.

According to his calculations, the new limit for flexible spending accounts will be $3,050, or a 7% increase over the current year’s upper limit of $2,850.

FSAs allow workers to put this limit into an account that can be used to pay for medical expenses. Since the money is taken out of their accounts on a pre-tax basis, it provides tax savings to many workers.

Pomerleau said the new IRA limit is likely to be $6,500 for 2023. That’s an increase of about 8% over the 2022 limit of $6,000.

“This will likely be the only time you’ll see a bump this big,” Pomerleau said of his forecast. “If inflation starts declining, which I think will happen, we’ll go back to more modest annual adjustments every year. This could end up being a one-off thing.”

Higher standard discount

Pomerleau said an increase in the standard deduction is also likely. In 2022, this deduction for individual taxpayers was $12,950, but it is estimated to rise to $13,850 in 2023.

Married couples who file a joint tax return have a standard deduction for 2022 of $25,900, but that could rise to $27,700 next year. Meanwhile, Pomerleau said household-headed applicants could see their record deduction rise from $19,400 this year to about $20,800 in 2023.

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