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Inflation and Taxes – Are there Benefits?

Inflation. It’s on everyone’s mind currently. From the increased prices of labor, gas, and shipping, to the outrageous food costs for chicken wings, milk, and the extravagant price of eggs, inflation is everywhere you look. Inflation is painful, and it’s practically as certain as death and taxes. So, what does inflation do to your taxes? Are there any benefits?

Inflation will impact several areas of taxes across both business and personal lines. You will most certainly pay more for goods and services. Additionally, you may have received an increase in your payroll check, but that may not necessarily mean an increase in the income tax bracket or percent of taxes due for your personal income taxes.

The personal income tax brackets are indexed for inflation. While it may not be a large savings, every little bit helps. First, let’s take a look at the increases in federal income tax brackets in relation to inflation from 2021 to 2022 to the projected rates for 2023. To follow are the income tax brackets for 2021 for each filing status: Married Filing Jointly (MFJ), Married Filing Separately (MFS), Head of Household (HOH), and Single. The marginal rate in the table below represents the federal percent of taxes on the taxable income in each tax bracket and the values in the columns represent the minimum taxable income level for each filing status that the marginal rate in the row begins to apply.

2021 Federal Tax Rates by Taxable Income Bracket

Rate

MFJ

MFS

HOH

Single

10%

>

-

-

-

-

12%

>

19,900

9,950

14,200

9,950

22%

>

81,050

40,525

54,200

40,525

24%

>

172,750

86,375

86,350

86,375

32%

>

329,850

164,925

164,900

164,925

35%

>

418,850

209,425

209,400

209,425

37%

>

628,300

314,150

523,600

523,600

How does the above table work? It’s like buckets. First you fill your first bucket at the 10% rate up to the 12% rate, next you fill your next bucket at the 12% rate up to the 22% rate, and so on. For instance, if you filed MFJ and you had $100,000 in total taxable income, the first $19,900 would be taxed at 10% (tax $1,990), then the next $61,150 ($81,050 - $19,900) would be taxed at 12% (tax $7,338), and the remainder of $18,950 ($100,000 - $81,050) would be taxed at 22% (tax $4,169). Then you add all your buckets together, which would equal $13,497 in tax ($1,990 + $7,338 + $4,169).

Where does inflation play in? Federal income tax brackets are adjusted each year by changes in the consumer price index (CPI). The average increase in the federal taxable income brackets for 2022 as compared with 2021 increased by an average of approximately 3.13%, resulting in the following table for 2022:


2022 Federal Tax Rates by Taxable Income Bracket

Rate

MFJ

MFS

HOH

Single

10%

>

-

-

-

-

12%

>

20,550

10,275

14,650

10,275

22%

>

83,550

41,775

55,900

41,775

24%

>

178,150

89,075

89,050

89,075

32%

>

340,100

170,050

170,050

170,050

35%

>

431,900

215,950

215,950

215,950

37%

>

647,850

323,925

539,900

539,900

Using our same example from above of $100,000 in taxable income filing MFJ, the calculated tax would now be $13,234 for 2022, resulting in $263 less in tax than 2021 on that same taxable income. How do we find the permanent tax savings? It is the consequence of the following inflation adjustments to the taxable income brackets, as relevant to our $100,000 taxable income example:

  • 10% taxable income bucket increased by $650 ($20,550 - $19,900), tax savings = $13
    • Calculated as $650 x 2% (12% - 10%)
  • 12% taxable income bucket increased by $2,500 ($83,550 - $81,050), tax savings = $250
    • Calculated as $2,500 x 10% (22% - 12%)
  • Total permanent tax savings resulting from inflation = $263 ($13 + $250)

Considering the recent extraordinary increases in food and gas prices, how will we obtain a permanent tax savings benefit from inflation next year? The projected increase in the federal taxable income brackets for 2023 as compared with 2022 is expected to increase by an average of approximately 7.08%, resulting in the following projections for 2023:

2023 Estimated Federal Tax Rates by Taxable Income Bracket

Rate

MFJ

MFS

HOH

Single

10%

>

-

-

-

-

12%

>

22,000

11,000

15,700

11,000

22%

>

89,450

44,725

59,850

44,725

24%

>

190,750

95,375

95,350

95,375

32%

>

364,200

182,100

182,100

182,100

35%

>

462,500

231,250

231,250

231,250

37%

>

693,750

346,875

578,100

578,125

Using our same example from above of $100,000 in taxable income filing MFJ, the calculated tax would now be $12,615 in tax for 2023, resulting in a permanent tax savings of $619 from 2022 on that same taxable income, more than 2.3 times the prior year’s tax savings.

Why is this significant to my current tax situation? Provided there are no major changes to income tax backets for 2023 other than adjustments for inflation, it may be beneficial to delay some income into 2023, if you are able to, which may result in a permanent tax savings, and more cash in your pocket. This is a great tax planning opportunity to discuss with your accountant or tax advisor.

In addition to the income tax brackets, the standard deduction will also be adjusted for inflation. The average increase from 2021 to 2022 was approximately 3.19%, and the 2023 increase is projected to be an average of approximately 7.02%, as follows:

Standard Deduction

Year

MFJ

MFS

HOH

Single

2021

25,100

12,550

18,800

12,550

2022

25,900

12,950

19,400

12,950

Est. 2023

27,700

13,850

20,800

13,850

How does the standard deduction work? It is the minimum deduction that reduces your gross income prior to taxes being assessed on your net taxable income. If you itemized your deductions, rather than taking the standard deduction, this would most commonly include costs for state and property taxes, mortgage interest, charitable contributions, etc. However, if the itemized deductions did not provide a value higher than the standard deduction, then you would utilize the standard deduction.

Using the standard deduction and the federal taxable income tables provided above, the following very simple examples will illustrate how inflation will impact your personal federal income taxes year over year (Y/O/Y), providing temporary and permanent tax savings:

Example 1:

Gross Income:

$100,000

Filing Status:

Single

Projected

year:

2021

2022

2023

Gross Income

100,000

100,000

100,000

Less: Standard Deduction

(12,550)

(12,950)

(13,850)

Net Taxable Income

87,450

87,050

86,150

Top Tax Bracket Marginal Rate

24%

22%

22%

Total Tax

15,009

14,768

14,261

Income, Net of Tax

84,991

85,232

85,739

Percent of income

84.99%

85.23%

85.74%

Increase in percent Y/O/Y

0.24%

0.51%

In the above Example 1, the taxpayer is filing as Single. From 2021 to 2022, the top tax rate would decrease from 24% to 22% on the same gross income. The net tax savings from 2022 to the projected 2023 would be approximately $507, which represents the permanent tax savings.

Additionally, the Single taxpayer in Example 1 could earn another $2,025 ($89,075 – $87,050) in taxable income during 2022 at the 22% taxable income bracket before the individual would be at the higher rate of 24% on income. Which means that there would be a temporary savings of tax on this same $2,025 if earned during 2023 instead of 2022, since the earnings would stay in the 22% tax rate bracket. However, during 2023, the threshold for the 24% taxable income bracket increases to $95,375, so pushing any additional earnings above $89,075 into 2023 would provide the permanent tax savings of 2% on the $6,300 increase in the taxable income bracket, which would provide for up to a $126 permanent tax savings Y/O/Y from 2022 to 2023.

Example 2:

Gross Income:

$450,000

Filing Status:

MFJ

Projected

year:

2021

2022

2023

Gross Income

450,000

450,000

450,000

Less: Standard Deduction

(25,100)

(25,900)

(27,700)

Net Taxable Income

424,900

424,100

422,300

Top Tax Bracket Marginal Rate

35%

32%

32%

Total Tax

97,804

96,175

92,800

Income, Net of Tax

352,196

353,825

357,200

Percent of income

78.27%

78.63%

79.38%

Increase in percent Y/O/Y

0.36%

0.75%

In the above Example 2, the taxpayer is filing as Married Filing Jointly (MFJ). From 2021 to 2022, the top tax rate would decrease from 35% to 32% on the same gross income. The net tax savings from 2022 to the projected 2023 would be approximately $3,375, which represents the permanent tax savings.

The MFJ taxpayer in Example 2 could earn another $7,800 ($431,900 – $424,100) of taxable income during 2022 at the 32% taxable income bracket before the individual would be at the higher rate of 35% on income. This would provide a temporary savings of tax on this same $7,800 if earned during 2023 as compared with 2022, since the earnings would stay in the 32% tax rate bracket. During 2023, the threshold for the 35% taxable income bracket increases to $462,500, so pushing any additional earnings above $431,900 into 2023 would provide the permanent tax savings of 3% on the $30,600 increase in the taxable income bracket, which would provide for up to a $918 permanent tax savings Y/O/Y from 2022 to 2023.

What’s the difference between a permanent and a temporary tax savings? As illustrated in the above two examples, if the same tax rate will apply to the taxable income in both years, the tax savings will be temporary. However, if the tax rate will be less on the taxable income in the 2023 year as compared with the 2022 year, then the difference in the rate will provide a tax savings portion that is permanent, meaning you will keep some of your cash rather than defer it.

Please note that other taxable income rates and other tax adjustments are also adjusted for inflation, but have not been included in the above information or examples.

However, if you have a business, the business mileage rate as determined by the Internal Revenue Service (IRS) was increased mid-way through 2022 due to inflation and increased gas prices. Therefore, the rate from January through June was 58.5 cents per mile, and the rate from July to December will be 62.5 cents per mile. A good tax planning tip would be to accurately document your mileage from both halves of the 2022 year so that you can appropriately benefit from the increased mileage rate for the second half of the 2022 tax year.

In summary, inflation will be impactful to many areas of your business and personally. Tax planning services can be advantageous in obtaining both temporary and permanent tax savings. Therefore, we recommend taking this opportunity over the next few months to consult with your tax advisor to explore options to obtain tax savings, keep more of your cash, and find the benefits in this current environment of high inflation.

This material has been prepared for general, informational purposes only and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. Should you require any such advice, please contact us directly. The information contained herein does not create, and your review or use of the information does not constitute, an accountant-client relationship.