The United States economy has been experiencing a sharp increase in inflation in recent times, with prices soaring at an unprecedented rate. In response to this, the federal government has announced a series of individual payroll tax adjustments for the year 2023, which could potentially help alleviate the effects of high inflation to some extent.
These payroll tax adjustments are typically announced annually and mainly concern wage caps, income tax brackets, and non-taxable contributions. The changes are designed to reflect the current economic conditions, and as an employer, it is essential to stay informed and aware of these adjustments to remain compliant and avoid penalties.
In this article, we will discuss the four major payroll tax changes that employers should prepare for in 2023.
1. Social Security Wage Base Increases by Nearly 9%
One of the significant payroll tax changes that employers need to be aware of in 2023 is the increase in the social security wage base. The social security wage base is the maximum income subject to social security tax, and it will increase from $147,000 to $160,200 starting January 1, 2023. This represents an almost 9% jump.
The Social Security Administration (SSA) announced this change in taxable income in October 2022 to reflect the increase in national average wages. While this is good news for social security beneficiaries, high-income earners whose income exceeds $147,000 will take home smaller paychecks.
The social security tax rate will remain unchanged at 6.2%, which is the larger part of the Federal Insurance Contributions Act (FICA) rate of 7.65%. This means that an individual will pay a maximum of $9,932.40 ($160,200 x 6.2%) in social security tax in 2023.
It is crucial for employers to communicate the new wage cap for social security taxes to every employee on their payroll, regardless of how much they earn. This should ideally be done before employees receive their first paychecks in 2023. Employers can use a company-wide memo from their HR department to inform employees and invite them to ask questions if necessary.
Employers should also proactively update their payroll system to reflect the higher wage cap for social security tax. They should speak to their service provider about this change if they do not do payroll internally to ensure that they are up-to-date.
2. Federal Income Tax Bracket Thresholds Increase by Almost 7%
The federal government helps taxpayers adjust to inflation by raising income tax bracket thresholds, which are the income ranges tied to the different tax rates. In 2023, the IRS has decided to increase the federal tax thresholds by almost 7% for every bracket.
The highlights of how the income tax brackets have changed for single-filers and joint-filers are as follows:
- 10% tax rate: $0 to $11,000 ($0 to $22,000 for married couples who file jointly)
- 12% tax rate: Above $11,000 to $44,725 (above $22,000 to $89,450 for married couples who file jointly)
- 22% tax rate: Above $44,725 to $95,375 (above $89,450 to $190,750 for married couples who file jointly)
- 24% tax rate: Above $95,375 to $182,100 (above $190,750 to $364,200 for married couples who file jointly)
- 32% tax rate: Above $182,100 to $231,250 (above $364,200 to $462,500 for married couples who file jointly)
- 35% tax rate: Above $231,250 to $578,125 (above $462,500 to $693,750 for married couples who file jointly)
- 37% tax rate: Above $578,125 (above $693,750 for married couples who file jointly)
Employees will be able to take larger paychecks home in 2023 due to being placed in lower brackets. However, some high-income earners may not see much difference as they will pay more in social security taxes.
Employers should adjust their payroll systems to account for these new brackets and encourage employees to do their due diligence to ensure that they are not overpaying. The IRS has an online tax withholding estimator that can help with this.
Employers should also remind employees about the new tax brackets before the change goes into effect so that they have ample time to plan for changes to their paychecks. Similarly, employers should expect employees to complete and resubmit their W-4 forms as the new thresholds will likely impact their financial situations.
3. Annual Contribution Limits for Retirement Plans Increase
The IRS has announced that it is going to expand the annual contribution limits for various retirement plans in 2023. Employees will be able to defer a larger amount of their paycheck to these plans and reduce their taxable wages.
The annual limits for traditional 401K, 403B, 457, and the Thrift Savings Plan will increase from $20,500 to $22,500. Furthermore, employees aged 50 years or above will be able to make additional catch-up contributions of up to $7,500 in 2023 to these plans (up from $6,500 in 2022).
Employees enrolled in Individual Retirement Plans (IRAs) will also get a relatively smaller sigh of relief in 2023 as annual contribution limits are set to increase from $6,000 to $6,500. However, the catch-up limit for IRAs remains $1,000 since the IRS does not adjust it for the cost of living. Yet, employees enrolled in SIMPLE plans will now be able to make catch-up contributions of $3,500 instead of $3,000.
Employers should inform employees about the new pre-tax contribution limits to retirement plans so that they can adjust their elective salary deferrals in due time. Employers should take this step as soon as possible if their plan(s) only allow participants to change their contributions during the open-enrollment season.
Employers should also accommodate employees who want to increase their elective deferrals to benefit from the higher contribution limit. If a third-party acts as the plan administrator, employers should make sure that they provide their employees with all the assistance they need to adjust their contributions. Finally, employers should ensure that their payroll system processes taxable incomes adjusted for newly elected deferrals (if applicable).
4. Annual Contribution Limits for Health Savings Account (HSA) Increase
The IRS has also announced that it is going to increase the annual contribution limits for HSAs in an effort to cancel out the effects of high inflation. According to the Revenue Procedure 2022-24, the changes to contribution limits are as follows:
- $3,850 for a person with self-only coverage (up from $3,650 in 2022)
- $7,750 for a person with family coverage (up from $7,300 in 2022)
Keep in mind that the above annual limits include contributions from both employees and employers. This change amounts to a near 5 to 5.5% increase in contribution limits for both coverages from 2022. For comparison, the annual contribution limits for HSAs only increased by about 1.4% between 2021 and 2022.
Employees will have the chance to contribute a slightly larger amount to their HSAs to reduce their taxable earnings. Although the difference is not that significant, every dollar saved counts in these harsh economic conditions.
Employers should be prepared to make any changes to how much employees choose to defer to their HSAs. Employers should tweak their payroll system to ensure the new adjustments are accounted for.
Employers should also consider contributing to their employees’ HSAs if they haven’t already. These contributions are also considered pre-taxed and can therefore help reduce the payroll tax employers pay.
The checklist summarizes all the payroll tax changes for 2023 in a very concise way. The document goes over the main, high-level updates and includes good-to-know actionable advice that employers can start implementing right away.
In conclusion, employers need to stay up-to-date with payroll tax changes to avoid hefty penalties and ensure compliance. The four major payroll tax changes for 2023 that employers need to prepare for are:
- Social Security wage base increases by nearly 9%
- Federal income tax bracket thresholds increase by almost 7%
- Annual contribution limits for retirement plans increase
- Annual contribution limits for health savings accounts increase
Employers should communicate these changes to their employees, adjust their payroll systems accordingly, and encourage employees to do their due diligence to ensure that they are not overpaying or underpaying taxes.