New tax rates explained
Five years ago, Congress passed the most far-reaching tax legislation since 1986, the Tax Cuts & Jobs Act of 2017, better known as the Trump Tax Cut. This made many changes to tax law. Some of these changes are adjusted every year for inflation, to eliminate “bracket creep.” That is when inflation would make you pay more in taxes and not get an increase in purchasing power. There are more than 60 tax provisions that are adjusted annually.
It is important to remember that the U.S. tax system is a progressive one. That means people with higher income pay more taxes. It is important to remember that not all money is taxed the same. What you get paid for working is considered ordinary income and is taxed at the highest rate. Some income receives special tax treatment, such as qualified dividends or long-term capital gains. They are taxed at a lower rate to promote investment in the economy. There is even some income, such as municipal bonds, which may be tax-free.
People are allowed to take a standard deduction off their income. For married couples filing jointly, this is $27,700. This is an increase of 7% from last year and the largest increase since 1985. People over 65 may add an additional $1,500 to their standard deduction. Both people in a couple can get this additional money, and you just need to reach 65 some time between Jan. 1 and Dec. 31. Single individuals receive $13,800, and head of household gets $20,800. You must have at least one more person living in your home to claim this distinction.
Most people use the standard deduction, but you can itemize instead if that is to your advantage. People with a lot of medical costs may be able to benefit, if that expense is more than 7.5% of adjusted income. Taxpayers who are paying long-term care costs can generally deduct a portion of their premiums as a qualified medical expense.
There are seven tax brackets along with a 0% tax rate. For 2023, a married couple filing jointly, the 10% rate is earnings of between zero to $22,000. Next comes 12, 22, 24, 32, 35, and 37% tax rates. The width of all of the brackets increased for 2023 to reflect our high inflation.
Remember, you still get the free money from your standard deduction. For example, a couple filing jointly and both over 65 get $30,700 of tax-free money. If their income was $30,800, they would pay 10% tax only on the $100 above their personal exemption or $10 of tax. No matter what tax bracket you end up in, you always get the free money and benefit from filling up the lower brackets. That means if your income ends up in the 22% bracket, your overall tax is much less.
The tax code is a huge document and there are many other changes that have gone into effect for 2023. The biggest mistake most people make is they are reactive instead of proactive in doing their taxes. Being reactive means you just collect your tax documents and have your return completed and the bill is whatever comes out. Being proactive means you have a tax plan to lower your bill and you take timely steps to save money.
Tax planning is important for everyone, but especially seniors with large amounts of qualified money. The widow’s penalty raises your tax rate significantly when there is only one of you, RMDs could force you into higher brackets and your Medicare cost could increase dramatically. To reduce this cost, your planning must start now.
Your Financial Future is written by certified financial planner Gary W. Boatman, MBA and CFP, who also wrote the book, “Your Financial Compass: Safe Passage Through The Turbulent Waters of Taxes, Income Planning and Market Volatility.” If there is an area that you would like to see discussed in the column, send your suggestions to gary@BoatmanWealthManagement.com.