Good to Know
If you saw twenty-two $100 bills lying on the sidewalk and could not determine who the money belonged to, would you scoop it up? If your answer to that question is yes, we have good news. That much or more in federal income tax savings for 2023 could be possible. Clients may reduce their federal taxable income by $11,000 or more through:
- New tax brackets,
- Higher standard deductions,
- Higher 401(k) deferral limits, and
- Higher IRA and Flexible Spending Arrangement contribution limits.
In the discussion that follows and for the sake of consistency, we’ll illustrate these concepts assuming a married-filing-jointly couple in the 22% marginal federal income tax rate bracket. However, state taxes on income may also apply. Forty states levy a tax on income—ten of those states assess a maximum tax of from 8% to over 13%; the remaining states have lower rates. As you consider the concepts in this article, be aware that savings on state tax may also accrue.
Our focus in this article is on opportunities to reduce the federal income tax and when we use the term “income tax” we are referring to the federal income tax.
We’ll begin with new tax brackets.
New Tax Brackets
More taxable income will be taxed at lower tax rates in 2023. Why? Because the 2023 inflation adjustments increased the amount of income taxed in lower brackets—resulting in less taxable income taxed at higher brackets. For example, assume a married filing jointly couple with $150,000 in taxable income; this couple gets a “free” $619 in reduced federal income tax in 2023 vs. 2022.
- This couple would have paid $24,234 in federal income tax for 2022.
- Their income tax bill drops to $23,615 on that same amount of taxable income using 2023 inflation-adjusted rate brackets.
Higher Standard Deductions
Standard deductions increased significantly in 2023. For example, the standard deduction for a married-filing-jointly couple increased by $1,800. That increase translates into almost $400 in income tax savings for couples in the 22% marginal income tax rate bracket.
Higher 401(k) Deferral Limits
Your client aged 50 or more can defer $3,000 more in 2023. A married couple in which both spouses defer into a 401(k) plan could reduce their married-filing-jointly federal taxable income by an impressive $6,000—translating into a $1,320 federal income tax savings in the 22% rate bracket.
Your clients should check with their plan administrator to be sure they’re deferring the maximum possible. For clients who place a high priority on retirement savings, it may be worthwhile to review discretionary expenses if current cash flow would not support the increased deferrals.
IRA and FSA Increases
The $500 increase for contributions to an individual’s IRA and the $200 increase to an individual’s Flexible Savings Arrangement could reduce a married-filing-jointly couple’s taxable income by $1,400, resulting in over $300 in federal income tax savings—22% marginal income tax rate assumed.
The great news about these tax-saving opportunities is that they are either automatic or require minimal action on your client’s part. The new tax rate brackets and standard deduction amount are automatic. Increasing 401(k) deferrals, IRA contributions, and FSA contributions will require minimal action by your clients. Why not scoop up the money “lying on the sidewalk?”