What higher inflation might mean for your tax bill

It’s tax season again — and after a year of record-high inflation, you might be wondering if you’ll end up with a record-high tax refund.

Unfortunately, higher prices are unlikely to correlate with lower taxes.

“Inflation will most likely be increasing our tax burden in April, not reducing it,” explains Andrew Cremé, a CERTIFIED FINANCIAL PLANNER™ professional who leads the Cremé Wealth Team at SageSpring Wealth Partners. “Throughout 2022, inflation was increasing significantly. However, the 2022 tax code was determined before all of that occurred.”

This means that, not only are you likely to find yourself in a higher tax bracket when filling out your tax returns this year, but you may also discover that your tax refund (if you receive one) has less purchasing power than it used to.

We asked the experts what you can do to lower your taxes, increase the value of your refund, and prepare for the upcoming tax season.

Will you be in a different tax bracket this year?

Prices went up in 2022 — but so did wages. If your income increased in the past year, you could find yourself in a higher tax bracket.

“The taxable wage rate went up on each tax bracket and the standard deduction limits all were increased, but not as much as wages,” Cremé told us. “For example, the bracket ranges and standard deductions were all increased around 3%, while wage growth was up 4.5%. Social Security benefits went up the most, by 5.9%.That translates to people being pushed into higher, less-favorable tax brackets.”

If you end up in a higher tax bracket this year, you could find yourself with a slightly higher tax burden. But remember that each marginal tax rate only applies to the income that falls within that margin. If you moved from the 22% to the 24% tax bracket, for example, you won’t be charged 24% on your entire income. You’ll only pay the 24% tax rate on any income above $89,075 ($178,150 for married couples filing jointly).

Will you get a smaller tax refund this year?

While we can’t predict the size of your tax refund, we can prepare you for a little bad news.

People who took advantage of the increased tax credits offered during the coronavirus pandemic may be surprised to see what happens to their tax refund now that some of these benefits are no longer available. The $300 charitable deduction credit that some taxpayers could claim even if they filed the standard deduction, for example, has been phased out. The Child Tax Credit is also lower this year than it was last year.

“The temporary increase to the Child Tax Credit did revert back at the end of 2021,” says Cremé, “so you no longer get $3,600 for children age 6 and under or $3,000 for children age 7 to 17.” Currently, the credit allows families to claim up to $2,000 per qualifying child, and the age cutoff has been reduced from 17 to 16 years old. “Depending on how many children you had that qualify, that could be a significant difference in tax savings.”

Is there still time to reduce your taxable income?

If you want to reduce your taxable income for the 2022 tax year, you have options.

“The first thing you can do to reduce your taxes is to contribute to donor-advised funds,” Cremé explains. “This is a way for you to fund an account that you give out of to charity for years to come. The nice thing is that you can front-load it and get a really big tax deduction.”

Keep in mind that charitable donations only reduce your tax burden if you itemize your deductions. If you’re planning to take the standard deduction, you’ll need to look for ways to lower your adjusted gross income — such as increasing your contributions to your health savings account.

“Use your HSA if you have an eligible health plan,” Cremé advises. “It allows for contributions up until tax filing deadlines, so you can actually use it as a way to reduce taxes after you’ve done your initial estimates — which is very handy.”

There’s one more way to reduce your taxable income in 2023 — especially if you spent part of last year’s bear market watching your investment portfolio lose value. “The last thing to consider to reduce taxes in 2023 is tax-loss harvesting,” says Cremé.

“This is when you sell your investments that have gone down in value to lock in a tax write-off in that tax year. It has to be in a non-retirement investment account, though — so it won’t work in IRAs or 401(k) plans.”

What should you do after you get your tax refund?

Think carefully before you spend your tax refund — because it may have less purchasing power than it did last year.

“You won’t get as much mileage out of your tax refund as you may have in the past,” explains Andrea Woroch, a financial expert with a focus in family budgeting. If you were hoping to put your federal income tax refund towards a big purchase, for example, you might want to hold off on your spending plans until prices drop — or look for coupons and deals that can help lower costs.

“Get more bang from your tax refund bucks by shopping savvy,” Woroch advises.

In some cases, saving your tax refund could be the smartest financial move. “If you’re saving your tax refund, you can get more out of it by putting it in a high-yield savings account to benefit from higher interest rates,” says Woroch. By putting your tax refund in a high-yield savings account, it can earn money while you wait for prices to go down. Your tax refund could also become part of your emergency fund.

You may also want to put your tax refund towards any outstanding credit card debt, especially if last year’s price increases added to your debt burden. While using your tax refund to pay off debt may feel a little disappointing, especially if you were hoping to use it for a family vacation or a long-overdue shopping spree, keep in mind that every dollar you put towards high-interest credit card debt has the potential to save you a lot of money in the long term.

Once you’ve gotten rid of those high monthly credit card bills, you can use the money you would have spent on debt repayment to make any purchases you’d been putting off — and if you’re lucky, prices will have gone down by then.