Important Tax Changes in 2023

Christine Benz: Hi, I’m Christine Benz from Morningstar. Inflation has driven a lot of the changes to the tax code in 2023. Joining me to discuss what you need to know about tax changes this year is tax and retirement planning specialist, Ed Slott.

Ed, thank you so much for being here.

Ed Slott: Thanks, Christine. Great to be back with you.

Benz: Great to have you here. Now, we want to talk about 2023 and what is changing for 2023. As we look across the changes, the tax changes we’re set to see this year, a lot of them do relate to inflation. Can you talk about that?

Slott: Yeah, everybody complains about inflation because everything costs more. But when you’re talking about taxes, it works to your benefit. We’ve seen the largest inflation increases I think we’ve ever seen going from 2022 to 2023. Expanded brackets. Remember, tax brackets have inflation increases each year based on the cost of living adjustments. They’re the largest in my knowledge they’ve ever been. Plus, it’s kind of a law of large numbers. As the numbers go up, the adjustment hits on a larger amount. So, you can push a lot more income into 2023 and stay at a low bracket. For example, for Roth conversions, you can convert a lot more in ‘23 with the expanded brackets than you could in ‘22 and stay in the lower brackets. So, it works to your benefit. The standard deduction is up substantially. The capital gain rates for who gets the 0% and all of that. Everything is to the taxpayer’s benefit because of the inflation increases.

Benz: And retirement plan contributions. Let’s talk about that because we are seeing higher allowable contribution limits. If people are thinking about their contributions for 2023, is it best to just elevate their contributions if they’re in a position to max out? Do that as soon as you possibly can, put those increases in place?

Slott: It always comes down to if you have the disposable income. We talk about this all the time. “Oh, the inflation amounts are up. You can put all this money now into a 401(k).” Oh, that’d be great if I had the money. Well, if you do have the money, yes, and I would always encourage, if you can, max out Roth 401(k)s and Roth IRAs. Even though Roth IRA and IRA limits are up for inflation, and those numbers don’t usually go up for years and they went up due to the high inflation numbers. Some of the catch-up contributions, not for IRAs—that stays for some reason at 1,000—but 401(k)s are up. If you have the income, yes, you can push more into your retirement savings.

Benz: And another area where we’ve been seeing some higher numbers is in the realm of the estate tax and gift tax.

Slott: Oh yeah.

Benz: Can you talk about those things? And also, I’m hoping you can clear up the confusion that often swirls around gift tax, especially where people think that if they give a gift above a certain level, they’ll automatically owe taxes on the gift. Can you demystify that a little bit?

Slott: Well, the estate exemption, I’m looking at it now. It’s again up the largest increase, up over—almost $900,000 increase over last year. We’re up to about—not about. For 2023, it’s $12,920,000 per person. A married couple, it’s a large amount—rough, say call it, $13 million, say $26 million for a married couple. That’s a lot to be able to give away totally tax-free. Remember this. We call it the estate exemption, but it’s also a gift exemption. You can give it away, but the party is going to end if the law doesn’t change after 2025 when these levels are supposed to revert to half of what they are. If this is your situation, you should look seriously at gifting. There are huge benefits to gifting, and I’m talking about pure cash.

First of all, it removes the asset from your estate. It removes the income it threw off from your estate. It removes the appreciation that would accrue in your estate from your estate. And best of all, it’s tax-free. I’ll say it again. It’s tax-free to the recipient, the person who gets the gift. Now, there are three tiers of tax-exempt gifting, and most people don’t take advantage of any of them. The easiest one is the annual exclusion gift. Now, that’s up to $17,000 per person per year. You can give that gift to any person once a year every year. A married couple could double that. It doesn’t have to be a family member. People ask me all the time. No, it could be somebody you like. It doesn’t have to be family. It could be anybody. So, you can give that.

Let’s go to an extreme example, Christine, just to make the point. Let’s say you had 1,000 friends, which you might have, Christine, and you want to give them each $17,000, the limit. Well, I think that comes to about $17 million. You could give that away totally tax-free, and it doesn’t even count in to your $12.9 million exemption. In fact, in essence, it expands that exemption, bringing it to, let’s say, almost $30 million, totally tax-free. So, you can use the annual exclusion gifts. No gift tax at all up to that exemption amount, the $12.9 million, which most people—that’s a lifetime amount, not a yearly amount—which most people won’t use.

Then the second tier is un—this may be the biggest loophole in the tax code that almost nobody uses—unlimited gifting to an unlimited group of people. This is for tuition or medical bills. The catch is, the gifts have to be paid directly, not to the recipient, not to your kids, directly to the provider, the college, the hospital, the university, directly to the provider—unlimited to an unlimited amount of people. For example, there was one case where a grandma paid college—not college tuition. It was K-12 tuition to a school for six grandchildren, prepaid it all in one shot. Totally acceptable. All in one shot. Doesn’t even have to be reported. People like that. And it doesn’t cut into your $12.9 million exemption. So, that’s the deal of the century. And I got to tell you, older people, at least my clients, that I’ve noticed, love that kind of gifting. They generally don’t like just handing out checks to kids, especially grandkids, because they’re always worried they’ll blow the money, they’ll squander it. But this they love, because the gift goes directly to the hospital, the college, the school, and they know their gifts are being used for the intended purpose. So they love that.

And then the third tier of tax-exempt gifting is using the exemption itself. The first two tiers, the annual exclusion gift and the tuition and medical direct gifts, don’t even cut into that. So, most people can make literally millions and millions of dollars in gifts without any gift tax. Now, for those listening or watching this, let’s say, well my estate is $20 billion, $30 billion. Would gifting help me? Yes. Even if you’ve used up your exemption, it’s still cheaper tax-wise to give during life than to leave it to them after death. You pay more in taxes, or your estate will after death. So, there are huge advantages and ways to give money. Now here I’m talking about cash. I’m not talking about giving appreciated stocks. That I wouldn’t give. Especially if you’re older, you’d rather leave that till you die so the kids get a step-up in basis on that. So, I’m talking about pure cash, not highly appreciated, say, stocks, which you want to hold till death.

Benz: Right. Now, we’ve been talking about silver linings related to inflation that are generally benefiting taxpayers in 2023. I want to talk about another change that might not be as welcome for many workers especially, it’s the amount of income that’s subject to Social Security tax. That number is going up. Can you discuss that?

Slott: Yeah. I don’t have the number in front of me, but I think it’s around $160,000. You can check that. I just saw it somewhere. I don’t know if you have it in front of you. But I remember—I hate to date myself—I think when I started, it was like $10,000. When you made over $10,000, you maxed out your Social Security. So, obviously, more money as a worker is going to come out of your check until you hit that threshold. And I’m not sure about that $160,000 number. I think it’s around there. So, that’s a lot you have to earn before you can stop contributing to Social Security. The Medicare amount in there, though, goes on forever. That’s unlimited.

Benz: Okay. Ed, always great to get your insights. Thank you so much for being here.

Slott: Thanks, Christine.

Benz: Thanks for watching. I’m Christine Benz from Morningstar.