Don't Mess With Taxes

Plus a look at how higher costs of living affect capital gains, youngsters' investment earnings, gifts, and more.

Image via Giphy

Them that got, are them that get.

Not only is that a lyric (and theme) from a fabulous Ray Charles song, it's a good synopsis of the current estate tax law, especially with 2023 inflation adjustments.

Many of the current wealth-related tax provisions help the richest among us stay that way. But some of them can help all of us, regardless of our income level, increase our relative wealth. And, as reviewed in this Part 6 of the ol' blog's annual tax inflation series, many of these high-dollar Internal Tax Code components are adjusted each year for inflation.

Next year, long-term investors will see more of their capital gains fall into those lower tax rate brackets. Those who've parlayed their market acumen into multimillions will be able to pass along even more of that large estate tax-free to heirs, as well as give more while still around to get thanks. And youngsters getting an early start in unearned income also can shield more of those dollars.

So let's get started on how we can, to borrow from Ray, got and get more in 2023

Lesser tax bite for capital gains: It's no secret that richer people tend to take the approach that that it's better to make your money work for you than to work for your money. Essentially, they get much if not most of their income from investing.

Part of the appeal here is that when investments are long-term, the profit they produce is taxed at a lower rate. The tax rates on the proceeds from assets held for more than a year are 0 percent, 15 percent and 20 percent. Which one applies depends on your overall income and filing status.

Thanks to changes made by 2017's Tax Cuts and Jobs Act (TCJA), there are separate income brackets for the three capital gains tax rates. The earnings to which the three long-term capital gains tax rates will apply in 2023 are shown in the table below:

For comparison, and to use where you're figuring your 2022 taxes, here are this year's long-term capital gains rates and income brackets:

In addition to capital gains tax rates listed in the tables, higher-income taxpayers may also have to pay an additional 3.8% net investment income tax.

And yes, there are other capital gains tax rates for other holdings, like collectibles, but they are affected by inflation.

Uncle Sam also collects capital gains taxes on estates and trusts.

For 2023, the maximum zero capital gains tax rate applies to estates or trusts worth up to $3,000. The top earnings level for an estate or trust to be taxed at 15 percent is $14,650. The 20 percent rate applies to these entities worth $14,641 or more.

For comparison, in 2022 the maximum zero capital gains tax rate applies to estates or trusts worth up to $2,800. The top earnings level for an estate or trust to be taxed at 15 percent is $13,700. The 20 percent rate applies to these entities worth $13,701 or more.

Estate tax exemption increase: Thanks to your investments over the years, you've been able to fulfill the goal of providing for your family here and now. You've also accumulated enough to be able to leave a generous amount to your heirs.

The good news for most of us is that we won't have to worry about the federal estate tax. A portion of what you leave is free from taxation by Uncle Sam, and that generally covered most U.S taxpayers.

Five years ago, the TCJA expanded the estate tax exemption amount even more. The exemption also is adjusted for inflation.

For 2023, the inflation adjustment means an individual can leave heirs a tax-free estate of up to $12.92 million. That's per person, so a married couple can protect nearly $25.84 million from estate taxation.

That's a nice increase from 2022's nontaxable estate assets level of $12.06 million pers person, and $24.12 million for married couples.

When an estate exceeds those tax-year amounts, then and only then is the federal estate tax, which can go as high as 40 percent, assessed on the overage.

Obviously, these ever-increasing (at least until the TCJA expires at the end of 2025 or is changed before then) multimillion-dollar exclusion amounts mean that the hubby and I — and our families and our friends — likely will never have to worry about the federal estate tax … unless we win the lottery!

Note, though, that you might have to worry about the state tax collector. A handful of states and the District of Columbia still have either an have an estate or inheritance tax — our old Maryland stomping grounds has both — and their exclusion levels are much, much lower than the federal level.

Estate and trust tax rates: There's also a tax, with its own rate schedule, on earnings from trusts and estates. This applies to income that trustees choose to retain rather than distribute to beneficiaries.

Under this system, higher rates kick in at lower income levels than the tax rates and income brackets for individual taxpayers. The design intentional to keep trusts from being used as tax shelters.

However, the TCJA lowered tax rates for trusts and estates, just like it did for individuals, at least through 2025. It also reduced the number of trust and estate tax brackets from five to four.

The estate and trust tax rates for 2022 and 2023 are shown in the table below.

Tax-free gifting, too: Sometimes people want to share their wealth while they are still around to get the thanks for their generosity.

Not only is that a heartwarming move, it could be tax smart. Giving away some of your assets could help keep your eventual estate out of Uncle Sam's hands when death and taxes finally converge.

The tax code allows you to give a specific amount, known as an annual exclusion, in gifts to others. This will help reduce your estate's value and there's no tax ramifications for the gift recipients.

For 2023, that exclusion amount is $17,000 per person. That's a grand more than the $16,000 you can give away — remember, Christmas isn't that far away! — for the 2022 tax year.

Like the estate tax exemption, the gift exclusion limits each year are per person. That means if you're married, you and your spouse each can give a combined $34,000 to the same person in 2023, up from the $32,000 amount for married couples in 2022.

Pulling out my handy calculator, that also means that a married couple with three kids and five grandchildren can each give those eight family members a combined gift total of $272,000 in 2023. That's up from the $256,000 in 2022 without facing gift tax consequences.

And despite my example, you (and your spouse) also can give these gifts to folks beyond your family. That's right. There's no familial relationship requirement. So if you have some spare cash and really enjoy the ol' blog, just let me know.

Also, the gifts are not limited to dollars. You can give assets valued up to the limit, such as gifts of real property and family heirlooms.

By bestowing your cash and property beforehand, you can reduce the amount of your assets left to be distributed after you're gone. This is a good way to dole out your estate the way you want and keep its value under the amount that will trigger the federal estate tax.

Even better, as long as you follow the rules, you won't face any gift tax.

Best of all, for those on your list, your gifts are not taxable to the recipients.

Adding up all those gifts: The major tax-related gifting rule is, of course, that you can't just give away all your riches to escape the tax collector. That's why the lifetime gift exemption, aka the unified credit against the estate tax, was created.

As the name indicates, the lifetime gift exemption is the total amount of gifts that can be given away tax-free by a person over his or her lifetime to any number of people.

It's easy to keep track of because it's the same as the annual estate tax exemption amount. Again, thanks to inflation that's $12.92 million (or $25.84 per married couple) in 2023, and $12.06 million (or $24.12 million for a married couple) this year.

If you do go over the lifetime gift exclusion, you will owe a 40 percent tax on those excessive gifts.

Counting the kiddie tax: Since this post started with a classic tune, I'm going to close this inflation segment with another financially astute song that could apply to the kiddie tax. As the marvelous Billie Holiday wrote and sang, God Bless the Child that's got his own.

Children often get their own when they receive financial gifts from their parents or other relatives. The monetary gifts are useful tax planning for the givers. They also can help teach the recipient child about making money work for them, rather than just working for money if the gifts are assets or the youngster decides to invest the cash.

Investments and their earnings have some additional tax considerations for young market mavens. When young people — up to age 23 if a full-time student or 18 if not going to college — have unearned income, generally from dividends and interest or distributed capital gains, that exceed certain limits, the kiddie tax comes into play.

The kiddie tax first appeared in 1986 as a legislative way to close a tax loophole for the wealthy. After a certain earnings level, a child's investment income was taxed at the same rate as that of their parents. By effectively raising the potential tax on the youngsters' passive income, the idea was that well-to-do adults wouldn't be so inclined to shift their wealth by putting it in their lower-taxed children's names.

So what's the earnings amount today that triggers the kiddie tax?

For 2023, a young investor's first $1,250 of unearned income is not taxable. That's a slight increase from the first $1,150 of unearned income that's not taxable in 2022.

Then the next $1,250 in unearned income in 2023 ($1,150 in 2022) is taxed at the child's tax rate, typically the lowest 10 percent rate.

Only when a child's investment earnings top the combined limit — $2,500 in 2023 (the untaxed $1,250 and the next $1,250 taxed at the child's rate) and $2,300 in 2022 — is the young financier's excess unearned income is taxed at higher rates that typically apply to their parents' taxes.

Parents can opt to include a child's gross income in the adults' gross income and calculate the kiddie tax there. One of the requirements for this parental election is that a child's gross income for 2023 must be more than $1,250 but less than $12,500. For 2022 taxes, the range is more than $1,150 but less than $11,500.

More inflation tax info on the way: Obviously, the songs from the Genius of Soul and Lady Day about getting more and getting your own were for all of us who are nowhere near the top 1 percent. But hey, I'll take any opportunity, however roundabout, to get their songs out there!

If, however, you are rich enough to worry about the latest estate et al taxes and their inflation adjusted amounts, you also know that inter-generational income and how to make, preserve, distribute, and pay taxes on it can get complicated. So you should hire a financial and tax adviser if you haven't already.

That adviser and tax expert can help you deal with not only the wealth-related taxes in this Part 6 of the 2023 tax inflation series, but also with all the other ways inflation might affect your taxes in the upcoming year. You can find those in the directory at the end of the first 2023 inflation item.

Thanks for reading this one and all the rest. And thanks especially for your tax inflation interest and explanation patience.