New 2023 Federal Tax Limits

Take-Away: Last week the IRS published the inflation adjusted limits for transfer taxes as well as new tax brackets for 2023. The impact of this year’s inflation is abundantly clear in Revenue Procedure 2022-38.

Estate and Gift Tax Exemptions:

• Basic Exclusion Amount: The transfer tax basic exclusion amount (a/k/a the applicable exclusion amount) increases to $12,920,000 (up from $12,060,000) per individual. This means that a married couple could gift up to $25,840,000 of their wealth without incurring a federal gift tax. For those individuals who previously used their entire basic exclusion amount making lifetime gifts, this means that they now have an additional $860,000 that they can gift without incurring a gift tax in 2023.

Comment: Recall that if this large basic exclusion amount is used prior to 2026, the lifetime gift will not be ‘clawed back’ into the donor’s taxable estate for federal estate tax computation purposes. However, the IRS’ Proposed ‘Anti-Claw Back’ Regulations published just a few months ago create an exception for lifetime transfers that are ‘includible’ in the donor’s taxable estate. Includible transfers would be those that are brought back into the donor’s taxable estate under IRC 2036-2038, the so-called ‘string provisions’ of the Tax Code. Thus, in order to take advantage of this increased basic exclusion amount, great care needs to be made in what assets are gifted using the increased basic exclusion amount. High risk assets like LLCs or FLPs where the likelihood of the IRS finding a ‘string’ or retained control by the donor should be avoided. Similarly, if the subject of the lifetime gift is real estate or a closely held business interest, it is imperative that a qualified appraisal by a qualified appraiser be used to document the value of the gift.

• Annual Exclusion Amount: The federal gift tax annual exclusion increases to $17,000 per donor per donee (up from $16,000.) Despite proposed legislation last year to limit the number or amount of a donor’s annual exclusion gifts, there is still an unlimited number of annual exclusion gifts that a donor can make in a calendar year.

Comment: There still exists the opportunity for a donor to make direct gifts of unlimited amounts for the payment of medical expenses and tuition. Recall, however, that to qualify for the annual exclusion gift opportunity, the gift must be of a present interest. Consequently, a gift of assets to a trust will not qualify as a gift of a present interest unless that gift is accompanied by a Crummey withdrawal right held by the beneficiary of the trust.

• Estate Tax Exemptions and Exclusions: For a farm or closely held business interest, some portion of its value is subject to reduced interest when the estate tax associated with that property interest is paid in installments over 13 years. Under IRC 6166 (and IRC 6601), the 2% interest rate on the portion of the federal estate tax due associated with that property interest is now capped at $1,750,000. For a qualified real property interest, e.g. a farm, that is part of a taxable estate, the reduction in the value of that real estate interest under IRC 2032A, is limited to $1,310,000.

Income Tax Brackets:

• Trusts and Estates: The highest marginal federal income tax rate (37%) imposed on an irrevocable trust or probate estate in 2023 is reached when the trust or estate’s accumulated income exceeds $14,450.
• Individuals:  The following are the federal income tax brackets for 2023. Tax rates will remain the same for 2023

10%    Individuals        $11,000 or less                                             Married       $22,000 or less

12%    Individuals        $11,001 to $44,725                                     Married       $22,001 to $89,450

22%    Individuals        $44,726 to $95,375                                     Married       $89,451 to $190,750

24%    Individuals        $95,376 to $182,100                                   Married       $190,751 to $364,200

32%    Individuals        $182,101 to $231,250                                 Married       $364,201 to $462,500

35%    Individuals        $231,251 to $578,125                                 Married       $462,501 to $693,750

37%    Individuals        $578,126 and higher                                    Married       $ $693,751 and higher

Standard Deduction Increases: The standard deduction increases over the 2022 amount. For married individuals who file jointly, the increase in the standard deduction is $1,800. For a single person, the increase is $900. For a head-of-household, the increase is $1,400.

Social Security Wage Base: The withholding of Social Security contributions from an individual’s wages increases to $160,200 for 2023 (up from $147,000 for 2022.) Note that there is no wage limit on the Medicare surtax of 0.9% which is imposed on individuals with incomes above $200,000 and married individuals with incomes about $250,000.

401(k) Maximum Contributions: The maximum amount an individual can contribute to a 401(k) account (or other similar elective retirement plans) increases to $22,500 in 2023. If the individual is over the age of 50, an additional ‘catch-up’ contribution can be made of an additional $7,500. In short, an employee over the age of 50 could contribute $30,000 to their 401(k) account in 2023.

Observation: One result from the income tax bracket increases is that an individual might enjoy more net income in 2023. They might also have more after-tax income with the $900 to $1.800 increase in the standard deduction. Balanced against that increase is that possibly more income could be withheld as the Social Security wage base increase creeps up by about $13,000. In addition, while there might be more ‘take-home’ income to enjoy, balanced against that net income is rampant inflation.