Tax Rates, Brackets, and Exclusions, Oh My!
/Many of you have heard me communicate about marginal and effective tax rates. To define this, an “effective tax rate” is the average tax rate, or what percentage of your annual income is needed to pay for taxes. The “marginal tax rate” applies to each additional level of income. That means, in our progressive tax system, taxpayers pay more in taxes as their income rises proportionately in each bracket. Therefore, the highest rate, or tax bracket the taxpayer is in, is not the rate they will pay on all their income. Segments of income will fall into different brackets. The taxpayer goes bracket by bracket, paying the percentage on the amount of income that falls within that tax bracket income range, until they have reached the bracket for which their total taxable income falls. Because of this system, taxpayers’ effective (average) tax rate can be significantly lower than their marginal tax rate.
Now that the effective and marginal rates have been explained, you may have heard about some changes to the tax brackets. This is nothing new. Each year has its cost-of-living increases. For 2023 the IRS increased tax brackets (ranges of income, not tax rates) by about 7% for every type of tax filer. This means you can earn more money and still be in the same tax bracket.
The top marginal rate remains at 37% for individual taxpayers (single filers) with incomes above $578,125 or for married couples (married filing joint) with income higher than $693,750. There is an obvious marriage penalty at the higher income brackets. The lowest marginal rate remains at 10% with single filers of $11,000 or less and married filing joint couples earning $22,000 or less. Income thresholds for capital gains were also adjusted due to inflation for this year, again by about 7%. The rates remain at 0%, 15% and 20% depending on taxable income.
A couple more important notes to think about while planning for 2023 include the increased gift tax exclusion. Each taxpayer may gift up to $17,000 to another non-spouse individual without paying a gift tax nor filing a gift tax return. I recommend if each spouse is gifting and the total is greater than the $17,000 exclusion to an individual, each spouse write and sign their own check to designate it as their own gift.
Finally, the unified tax credit provides every American taxpayer a set amount that may be gifted during their lifetime or passed on as part of their estate exempt of taxes. For 2023, that amount is $12.92 million per individual. Note that this exemption could go back to a reduced amount in the future. Therefore, if a spouse passes, it may benefit the surviving spouse to file for portability of the unused exemption.
- Pam Smitson, CPA, CGMA, Smitson Erhart-Graves Financial Advisors
