October 2022

The IRS recently issued its 2023 cost-of-living adjustments for more than 60 tax provisions. With inflation up significantly this year, many amounts increased considerably over 2022 amounts. As you implement 2022 year-end tax planning strategies, be sure to take these 2023 adjustments into account.

Also, keep in mind that, under the Tax Cuts and Jobs Act (TCJA), annual inflation adjustments are calculated using the chained consumer price index (also known as C-CPI-U). This increases tax-bracket thresholds, the standard deduction, certain exemptions and other figures at a slower rate than was the case with the consumer price index previously used, potentially pushing taxpayers into higher tax brackets and making various breaks worth less over time. The TCJA adopts the C-CPI-U on a permanent basis.

Individual income taxes

Tax-bracket thresholds increase for each filing status but, because they’re based on percentages, they increase more significantly for the higher brackets. For example, the top of the 10% bracket increases by $725, to $1,450, depending on filing status, but the top of the 35% bracket increases by $22,950 to $45,900, again depending on filing status.

The TCJA suspended personal exemptions through 2025. However, it nearly doubled the standard deduction, indexed annually for inflation through 2025. For 2023, the standard deduction will be $27,700 (married couples filing jointly), $20,800 (heads of households), and $13,850 (singles and married couples filing separately). After 2025, standard deduction amounts are scheduled to drop back to the amounts under pre-TCJA law unless Congress extends the current rules or revises them.

Changes to the standard deduction could help some taxpayers make up for the loss of personal exemptions. But it might not help taxpayers who typically used to itemize deductions.

AMT

The alternative minimum tax (AMT) is a separate tax system that limits some deductions, doesn’t permit others and treats certain income items differently. If your AMT liability is greater than your regular tax liability, you must pay the AMT.

Like the regular tax brackets, the AMT brackets are annually indexed for inflation. For 2023, the threshold for the 28% bracket will increase by $14,600 for all filing statuses except married filing separately, which increased by half that amount.

The AMT exemptions and exemption phaseouts are also indexed. The exemption amounts for 2023 will be $81,300 for singles and $126,500 for joint filers, increasing by $5,400 and $8,400, respectively, over 2022 amounts. The inflation-adjusted phaseout ranges for 2023 will be $578,150–$903,350 (singles) and $1,156,300–$1,662,300 (joint filers). Amounts for married couples filing separately are half of those for joint filers.

Education and child-related breaks

The maximum benefits of certain education and child-related breaks generally remain the same for 2023. But most of these breaks are limited based on a taxpayer’s modified adjusted gross income (MAGI). Taxpayers whose MAGIs are within an applicable phaseout range are eligible for a partial break — and breaks are eliminated for those whose MAGIs exceed the top of the range.

The MAGI phaseout ranges will generally remain the same or increase modestly for 2023, depending on the break. For example:

The American Opportunity credit. For tax years beginning after December 31, 2020, the MAGI amount used by joint filers to determine the reduction in the American Opportunity credit isn’t adjusted for inflation. The credit is phased out for taxpayers with MAGI in excess of $80,000 ($160,000 for joint returns). The maximum credit per eligible student is $2,500.

The Lifetime Learning credit. For tax years beginning after December 31, 2020, the MAGI amount used by joint filers to determine the reduction in the Lifetime Learning credit isn’t adjusted for inflation. The credit is phased out for taxpayers with MAGI in excess of $80,000 ($160,000 for joint returns). The maximum credit is $2,000 per tax return.

The adoption credit. The phaseout ranges for eligible taxpayers adopting a child will also increase for 2023 — by $15,820, to $239,230–$279,230 for joint, head-of-household and single filers. The maximum credit will increase by $1,060, to $15,950 for 2023.

(Note: Married couples filing separately generally aren’t eligible for these credits.)

These are only some of the education and child-related breaks that may benefit you. Keep in mind that, if your MAGI is too high for you to qualify for a break for your child’s education, your child might be eligible to claim one on his or her tax return.

Gift and estate taxes

The unified gift and estate tax exemption and the generation-skipping transfer (GST) tax exemption are both adjusted annually for inflation. For 2023, the amounts will be $12.92 million (up from $12.06 million for 2022).

The annual gift tax exclusion will increase by $1,000 to $17,000 for 2023.

Retirement plans

Nearly all retirement-plan-related limits will increase for 2023. Thus, depending on the type of plan you have, you may have limited opportunities to increase your retirement savings if you’ve already been contributing the maximum amount allowed:

Your MAGI may reduce or even eliminate your ability to take advantage of IRAs. Fortunately, IRA-related MAGI phaseout range limits all will increase for 2023:

Traditional IRAs. MAGI phaseout ranges apply to the deductibility of contributions if a taxpayer (or his or her spouse) participates in an employer-sponsored retirement plan:

For married taxpayers filing jointly, the phaseout range is specific to each spouse based on whether he or she is a participant in an employer-sponsored plan:
- For a spouse who participates, the 2023 phaseout range limits will increase by $7,000, to $116,000–$136,000.
- For a spouse who doesn’t participate, the 2023 phaseout range limits will increase by $14,000, to $218,000–$228,000.
For single and head-of-household taxpayers participating in an employer-sponsored plan, the 2023 phaseout range limits will increase by $5,000, to $73,000–$83,000.

Taxpayers with MAGIs in the applicable range can deduct a partial contribution; those with MAGIs exceeding the applicable range can’t deduct any IRA contribution.

But a taxpayer whose deduction is reduced or eliminated can make nondeductible traditional IRA contributions. The $6,500 contribution limit for 2023 (plus $1,000 catch-up, if applicable, and reduced by any Roth IRA contributions) still applies. Nondeductible traditional IRA contributions may be beneficial if your MAGI is also too high for you to contribute (or fully contribute) to a Roth IRA.

Roth IRAs. Whether you participate in an employer-sponsored plan doesn’t affect your ability to contribute to a Roth IRA, but MAGI limits may reduce or eliminate your ability to contribute:

For married taxpayers filing jointly, the 2023 phaseout range limits will increase by $14,000, to $218,000–$228,000.
For single and head-of-household taxpayers, the 2023 phaseout range limits will increase by $9,000, to $138,000–$153,000.

You can make a partial contribution if your MAGI falls within the applicable range, but no contribution if it exceeds the top of the range.

(Note: Married taxpayers filing separately are subject to much lower phaseout ranges for both traditional and Roth IRAs.)

Crunching the numbers

With the 2023 cost-of-living adjustment amounts soaring higher than 2022 amounts, it’s important to understand how they might affect your tax and financial situation. We’d be happy to help crunch the numbers and explain the best tax-saving strategies to implement based on the 2023 numbers.

Mitigating the adverse effects of climate change is one of the primary targets of the recently enacted Inflation Reduction Act (IRA). To that end, the legislation is packed with tax incentives, including the significant expansion and extension of two tax deductions for energy-efficient construction. The changes to the Section 179D deduction for commercial buildings and the Section 45L credit for residential homes increase their potential value and make them available to more taxpayers than ever before.

Sec. 179D deduction

The Sec. 179D deduction has been around since 2006 but was made permanent only recently, by the Consolidated Appropriations Act. The IRA adds changes that substantially boost the size of the potential deduction and expand the pool of eligible taxpayers.

Pre-IRA, the deduction generally was limited to the owners of commercial properties or residential properties that are four stories or higher. The deduction also could be assigned to “designers” (including architects and engineers) of buildings owned by government entities.

To claim the deduction, a taxpayer was required to show a 50% reduction in energy and power costs. The deduction amount was up to 63 cents per square foot for each of three eligible systems (HVAC and hot water, interior lighting and building envelope). The maximum deduction was $1.88 per square foot (adjusted for inflation). Taxpayers could get a partial deduction if they couldn’t show the requisite savings in all three systems and the deduction could be claimed only once per property.

The IRA keeps these requirements intact for the remainder of 2022 but makes some major changes starting on January 1, 2023. For starters, the qualification threshold drops to 25% energy savings, with a base deduction of 50 cents per square foot.

If, however, the project satisfies prevailing wage and apprenticeship requirements for laborers and mechanics, you can qualify for the so-called “bonus” deduction of up to $2.50 per square foot. This deduction amount increases on a sliding scale:

If you qualify for the bonus, your deduction increases by 10 cents for each percentage point of energy savings above 25%, up to a 50% reduction, maxing out at $5 per square foot.
If you don’t qualify for the bonus, your deduction increases by 2 cents for each percentage point of energy savings beyond 25%, again up to 50%, for a maximum deduction of $1 per square foot.

The IRA brings other changes, too. For example, it eliminates the availability of partial deductions, and it allows all tax-exempt entities — not just government entities — to assign their deductions to designers.

The law also revises the standard for determining the amount of energy savings. Currently, the determination is made using the American Society of Heating, Refrigerating and Air-Conditioning Engineers (ASHRAE) standard in effect two years prior to the start of the construction. Under the IRA, energy savings will be evaluated under the ASHRAE standard from four years prior to completion of construction.

In addition, the deduction is no longer “one and out.” You can claim it again every three tax years (four years for buildings that are owned by government or tax-exempt entities) for subsequent energy-efficient improvements.

And the IRA creates a new alternative deduction path for renovation projects. To be eligible, you must have a qualified retrofit plan and reduce the building’s energy use “intensity” by at least 25% (as opposed to annual energy and power costs) compared to before the retrofit. Qualifying taxpayers can claim the retrofit credit in the qualifying final certification year. The deduction amount can’t exceed the total adjusted basis of the retrofit property placed in service.

Sec. 45L credit

The Sec. 45L credit also first became available in 2006, but it expired at the end of 2021. The credit applied to “eligible contractors” that built energy-efficient single-family, manufactured and low-rise multifamily residences. To qualify, the residences had to be 50% more energy-efficient than a standard dwelling unit that complies with the 2006 International Energy Conservation Code standards. The maximum credit was $2,000 per unit, with no partial credit permitted.

The IRA revived the Sec. 45L credit, extending it in its original form for qualifying buildings placed in service in 2022, with the same eligibility requirements and credit amount. Beginning in 2023 and running through 2032, though, the credit will be available for residential properties of any size, including those that exceed three floors. This means that multifamily properties that are four or more floors will be able to qualify for both 179D and 45L.

However, the IRA imposes more stringent standards for determining energy savings. Properties must satisfy the U.S. Department of Energy’s Energy Star Manufactured New Homes Program or Energy Star Residential New Construction Program requirements.

The base credit amount changes in 2023, too. It increases to $2,500 per unit for single-family Energy Star homes and falls to only $500 per unit for Energy Star multifamily homes. But taxpayers might qualify for much larger credits by fulfilling additional criteria.

If a property meets the requirements for the even stricter Zero Energy Ready Home program, the credit jumps to $5,000 per single-family unit and $1,000 per unit for multifamily homes. The credit for an Energy Star multifamily property goes up to $2,500 per unit if the property satisfies prevailing wage requirements, or $5,000 per unit if it’s also Zero Energy Ready.

Make the most of the IRA

The Sec. 179D and 45L incentives are only the tip of the iceberg when it comes to the IRA’s energy-related tax provisions affecting both personal and business property. We can help you leverage all of the applicable opportunities to minimize your federal tax liability.

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Month: October 2022

What do the 2023 cost-of-living adjustment numbers mean for you?

Inflation Reduction Act expands deductions for energy-efficient construction

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