Inflation, Taxes, Social Security: Are you getting a raise in 2023?

By now, investors are all too familiar with inflation’s impact on the costs of everyday items. Food, shelter, and energy all saw price increases not seen since the 1980s. But there may be somewhat of a silver lining as it relates to taxes.

To help offset the impacts of inflation, the federal government adjusts tax brackets, deduction amounts, and Social Security payments. It reflects the government’s attempt to keep taxpayers whole regarding their purchasing power versus the impact of increasing price levels. For the tax code, they are looking to fight “bracket creep” caused by inflation.

If tax brackets were not adjusted for inflation, as taxpayers realized higher income in line with inflation, their higher income would face higher taxes.

Tax brackets

Tax rates don’t change due to inflation, but tax brackets are adjusted for the impact of inflation. In addition, certain deductions and credits are adjusted. For some taxpayers, these changes could mean you will owe less taxes in 2023 than in 2022.

Broadly, tax brackets increased by 7% year over year in 2023—an increase not seen in many years[1]. If one’s taxable income was not increased by more than 7%, you may owe less taxes in 2023 than in 2022—thanks to higher-than-average inflation in 2022.

Let’s focus on taxpayers with a filing status of Married Filing Jointly:

Because of the progressive nature of these tax tables, the impact flows through each bracket. Assume two married couples with taxable income of $250,000 and $500,000 in 2022 and 2023. All taxble income is assumed to be ordinary with no unearned income (investment income):

Don’t forget the standard deduction in calculating taxable income.

One of the bigger changes to the tax code from the Tax Cut and Jobs Act passed in 2017 was the near doubling of the standard deduction. This increase led many taxpayers to no longer itemize certain deductions (taxes, interest expense, healthcare expenses, etc.) on the Schedule A, instead subtracting the standard deduction from gross income to derive taxable income. The inflation adjustment here was the largest since 1985.

Again, looking at the tax filing status of Married Filing Jointly:

For taxpayers in the 35% and 24% marginal tax brackets, this equals to tax savings of $630 and $432, respectively. Maybe small, but not nothing. No one would say no to an extra $432.

Social Security and estate taxes:

The Social Security Administration increased benefits in 2023 by 8.7%. This is the largest increase in payments since 1981![2] The importance of this increase is highlighted by 30% of retirement income for seniors coming from these payments.

Assets passed to heirs for deaths in 2023 will not need to pay estate taxes for inherited assets on the first $12.9 million (per person).[3] This is an increase of $860,000 that can be sheltered from the estate tax. So that is good news – except for the dying part.

Putting it together

No one likes paying taxes. And no one likes prices going up – especially faster than they have grown accustomed to. It’s good to remind clients that the federal government has balancing triggers in the system to try and offset some of the negative impacts of inflation. If their taxable income stays the same, their tax bill will likely be less. And for retirees? Well, they received their largest raise since 1981.

The question is: Do you know your clients’ marginal and effective tax rates? Bringing these rates up may help you have tax-smart discussions with your clients and prospects. Without knowing these rates, making informed decisions for taxable investment accounts can be very challenging (if not impossible). Using these tax brackets is an opportunity for additional fact-finding.

[1] Inflation Causes IRS to Raise Tax Brackets, Standard Deduction by 7% – WSJ

[2] Source: Social Security Administration; Social Security COLA will be 8.7% in 2023, highest increase in 40 years (cnbc.com)

[3] Estate Tax | Internal Revenue Service (irs.gov)