Inflation and your taxes: What you need to know
Though prices have begun to moderate, inflation adjustments already made for tax year 2023 (and anticipated for 2024) could affect how much Federal income tax you owe. These strategies can help.
WE FEEL THE IMPACT OF INFLATION as consumers every day, but did you know that rising prices could also affect your tax picture? Federal tax brackets and many benefits are adjusted annually for inflation. So even though the rate of price increases has come down considerably since the beginning of the year, taxpayers could notice changes when it comes time to calculate what they owe. Inflation can be mixed news for taxpayers, reports the Chief Investment Office’s National Wealth Strategies (NWS) team. Your tax bill could be higher — or lower — as a result.
Inflation can be mixed news for taxpayers. Your tax bill could be higher — or lower — as a result.
And inflation isn’t the only factor to consider. Market volatility and elevated interest rates — two other factors in the current environment — while disconcerting, may also create opportunities for tax-efficiency. Now may be a good time to speak with your tax advisor about how these forces could affect your tax picture and ways you might consider responding.
A recent NWS report from the Chief Investment Office (CIO), “Inflation, Market Volatility and Rising Interest Rates: Tax Consequences and Favored Planning Techniques,” could help guide that conversation. Below are a few potential changes to be aware of:
Tax bracket and retirement savings adjustments could lower your federal tax bill
Taxpayers should familiarize themselves with the inflation adjustments to federal tax brackets and many federal benefits that apply to this tax year. For instance, notes the NWS team, 2023 tax bracket income caps and the thresholds for determining capital gains brackets have increased, and the standard deduction was also adjusted upwards. In addition, caps on IRA and retirement savings account contributions have been raised for 2023, providing potentially higher tax deductions.1 Combined, these adjustments mean that you could potentially find yourself in a lower tax bracket — even if you received a raise this year. We expect similar, but more modest, adjustments for 2024.
But keep in mind that these changes may only apply to your federal taxes; not all states follow the federal model of adjusting for inflation. Many don’t adjust tax brackets, standard deductions or personal exemptions. Ask your tax advisor about your state’s provisions.
Social Security adjustments could bump you into a higher federal tax bracket
Social Security benefits are adjusted as the cost of living increases. In 2023, recipients received an 8.7% increase in benefits, the highest in 40 years.2 “The last time we saw a bigger increase was in 1981 — the average increase over the past 22 years was about 2.3%,3 notes the NWS team.
Social Security payments are scheduled to rise again in 2024, but at a more moderate increase of 3.2%. This inflation, or cost-of-living, adjustment is based on a comparison of prices during the July to September window compared with the prior year and therefore may not reflect the inflation consumers feel. An expected rise in Medicare Part B premiums will likely offset some of the benefits of the Social Security increase.
Watch out for the 3.8% net investment surtax
Even at the federal level, some key tax provisions, such as the 3.8% net investment surtax for couples earning $250,000 and up (or $200,000 for individuals) are not adjusted for inflation. Nor is the $500,000 exclusion ($250,000 for individuals) from gain on the sale of a primary residence. With wages and prices rising in response to inflation, more Americans may be subject to the 3.8% tax or exceed the residence exclusion.
4 strategies to discuss with your tax advisor
No matter where you land after all these inflation adjustments are factored into your tax situation, current economic and market conditions could make the following tax-aware strategies especially attractive.
Converting to a Roth IRA at a time when your investments may be temporarily lower due to volatility could help reduce your tax obligation when you convert.
Tax-loss harvesting. Considering recent market volatility, you may have experienced some losses. By selling those assets, you could potentially use the losses to offset current or future gains. Your tax advisor can explain some important caveats to this strategy.
Roth IRA Conversion. If you’re thinking about converting assets in a traditional IRA to a Roth IRA, 2023 might be a good year to do so, notes the NWS team. But you’ll have to pay tax on any previously untaxed IRA contributions and gains when you convert. Still, converting to a Roth IRA at a time when your investments may be temporarily lower due to volatility could help reduce your tax obligation when you convert, and for a unique set of taxpayers 2023 could be an especially good year to convert to a Roth IRA. The SECURE Act 2.0 increased the age for mandatory retirement plan distributions to age 73 effective January 1, 2023. Without the need to take a mandatory distribution, certain taxpayers may be in a lower tax bracket, providing an ideal time to convert to a Roth IRA.
Lifetime gifts. The current $10 million lifetime gift tax exemption is indexed annually for inflation. For 2023, the exemption stands at $12.92 million and will rise to $13.61 million in 2024. But in 2026 the exemption is scheduled to drop to about $7 million. If you own assets that have declined in value, now may be a good time to include those in your gifting plans. Temporarily reduced values could enable you to give that much more without triggering gift taxes, the NWS team points out.
Trusts. Depending on your financial goals, a variety of trust strategies may also be worth considering at a time when equity values are lower and interest rates have risen. If you have existing trusts intended to last a long time that are not yet exempt from generation-skipping tax (GST), the current environment may be a good time to consider allocating your GST exemption to those trusts.
Read the full report for a more detailed explanation of these and other strategies. And keep in mind that taxes quickly become complex, so be sure to speak with a tax advisor before making any decisions.