Your clients depend on you to keep them up-to-date on the latest changes in federal, state, and local tax laws. Staying current throughout the year can make tax season a lot smoother for both of you.
For 2023, the IRS pushed up many of its inflation adjustments by about 7%, which could help taxpayers avoid bracket creep. Here are some other key changes:
1. Tax Brackets
Tax brackets set the range of income that gets taxed at a certain rate. In the United States, there are seven different tax brackets, ranging from 10% to 37%. Each year, the IRS adjusts tax bracket thresholds for inflation. This helps avoid “bracket creep,” where taxpayers are pushed into higher tax brackets without receiving any commensurate benefit from their increased wages.
The IRS uses the chained consumer price index to make these inflation adjustments. This method takes into account the substitutions that consumers make in response to rising prices. This allows the IRS to better gauge the impact of inflation on income levels and deduction amounts.
The top marginal income tax rates also vary from state to state. Individual income taxes account for 49% of all state tax revenues, according to Fiscal Data. However, the number of states that collect these taxes differs. Most states only tax wage and salary income, while New Hampshire taxes interest and dividend income and Washington taxes capital gains.
Deductions reduce the amount of income that’s subject to taxation. Taxpayers can claim either a standard deduction or itemized deductions. Itemized deductions include home mortgage interest, charitable contributions and state and local taxes paid.
Prior to the 2017 tax act, taxpayers itemized deductions on almost 47 million tax returns. They saved nearly $1.4 trillion, which is equivalent to their aggregate taxable income being $925 billion higher than it would have been without the itemized deductions.
Itemized deductions benefit higher-income households more than lower-income households, because their incomes are generally greater and they have more expenses or losses that can be deductible. However, the per-dollar benefits of deductions decline as taxpayers reach the top income tax brackets. That’s because the marginal tax rate rises along with income. Credits, on the other hand, don’t have this effect. The credit for children’s health coverage, the earned income tax credit and the net operating loss (NOL) business credit are examples of credits.
3. Tax Credits
As you prepare to file your 2022 taxes, there are some important tax changes to consider. Some of the provisions that were put into place by the Tax Cuts and Jobs Act passed in 2017 will “sunset” or no longer apply, while others may have been extended or altered.
Tax credits reduce a taxpayer’s final tax liability dollar for dollar. This differs from deductions, which simply reduce taxable income. Tax credits are also categorized as refundable or nonrefundable. A refundable credit allows you to receive a refund of any portion of the credit that exceeds your tax liability, while a nonrefundable credit only reduces a taxpayer’s tax liability until it reaches zero.
Recent tax reform proposals include new provisions that encourage families to go solar, support research into rare diseases and incentivize green energy investment. Some of these proposals have already been implemented and some are still being debated by Congress. In addition, the IRS has issued interpretive regulations and other guidance on these new tax laws.
4. Payroll Taxes
Payroll taxes are taxes withheld from an employee’s paycheck for the purpose of funding federal programs such as Social Security and Medicare. These taxes are collected by the employer and reported to the IRS on a quarterly basis.
Payroll taxation can have a variety of effects on taxpayers. For example, higher marginal tax rates have a tendency to cause people to shift from taxable income sources such as wages and salaries to nontaxable forms of income such as capital gains and dividends.
Moreover, payroll taxes can have a detrimental effect on the economy by reducing incentives for individuals to work and increasing the cost of living. The TCJA has also reduced the deductibility of business interest expenses, which may encourage some businesses to move away from debt financing.