Taxation Of Social Security Benefits
Background Since a pair of 1938 Treasury Department Tax Rulings, and another in 1941, Social Security benefits have been explicitly excluded from federal income taxation. This changed for the first time with the passage of the 1983 Amendments to the Social Security Act. Beginning in 1984, a portion of Social Security benefits have been subject to federal income taxes.
The three Treasury Rulings established as tax policy the principle that Social Security benefits were not subject to federal income taxes. This was special treatment for Social Security benefits since most private pensions are partly taxable. In most private pensions, an amount of the pension equal to the contributions made by the worker are tax-free. The amount of such private pensions which exceeds the amount of the worker’s contributions, is usually subject to federal income taxes.
Yet another way of describing this idea is to use “exclusion ratios,” which is how the Treasury Department defines the taxable portion of a pension benefit. In all of these ways of describing it, the basic idea is the same: the pension recepient is generally liable for taxes on that portion of his benefits that he did not himself contribute.
Thus, the proposal as it emerged was for 50% of Social Security benefits to be subject to federal income tax, with threshold exclusions set at the same levels as those used for Unemployment Compensation .
In explaining the rationale for these changes, the House Budget Report stated:
Is Social Security Income Taxable
According to the IRS, the best way to see if youll owe taxes on your Social Security income is to take one half of your Social Security benefits and add that amount to all your other income, including tax-exempt interest. This number is known as your combined income, and this is how its calculated:
Combined Income = Adjusted Gross Income + Nontaxable Interest + 1/2 of Social Security benefits
If your combined income is above a certain limit , you will need to pay at least some tax. The limit for 2022 is $25,000 if you are a single filer, head of household or qualifying widow or widower with a dependent child. The 2022 limit for joint filers is $32,000. However, if youre married and file separately, youll likely have to pay taxes on your Social Security income.
State Taxes On Social Security
Twelve states tax Social Security benefits in some cases. Check with your state tax agency if you live in one of these statesColorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, Rhode Island, Utah, Vermont, or West Virginia. As with the federal tax, how these agencies tax Social Security varies by income and other criteria.
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Higher Social Security Tax Threshold
The SSA is mainly funded from payroll taxes that are typically split between employees and employers, with self-employed individuals picking up the full amount themselves. As the AARP noted, the tax rate hasnt changed in years, but the amount of income subject to it increases along with the COLA.
In 2022, employees had to pay Social Security taxes on annual income up to $147,000. In 2023, the threshold rises to $160,200, meaning neither you nor your employer will have to pay Social Security taxes on any income above that level.
How Do I Determine If My Social Security Is Taxable
Add up your gross income for the year, including Social Security. If you have little or no income besides your Social Security, you wont owe taxes on it. However, if youre an individual filer with at least $25,000 in gross income, including Social Security for the year, then up to 50% of your Social Security benefits may be taxable. For a couple filing jointly, the minimum is $32,000. If your gross income is $34,000 or more , then up to 85% may be taxable.
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Up To 85% Of A Taxpayers Benefits May Be Taxable If They Are:
- Filing single, head of household or qualifying widow or widower with more than $34,000 income.
The Interactive Tax Assistant on IRS.gov can help taxpayers answer the question Are My Social Security or Railroad Retirement Tier I Benefits Taxable?
The tax filing deadline has been postponed to Wednesday, July 15, 2020. The IRS is processing tax returns, issuing refunds and accepting payments. Taxpayers who mailed a tax return will experience a longer wait. There is no need to mail a second tax return or call the IRS.
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How Much Of Your Social Security Is Taxable
Its possible and perfectly legal to avoid paying taxes on your Social Security check. In fact, only about 40 percent of recipients pay any federal tax on their benefit.
But heres the caveat: To receive tax-free Social Security, your annual combined, or provisional, income must be under certain thresholds:
- $25,000, if youre filing as an individual
- $32,000, if youre married filing jointly
For married filing separately, the Social Security Administration simply says that youll probably pay taxes on your benefits.
Your combined income consists of three parts:
- Your adjusted gross income, not including Social Security income
- Tax-exempt interest
- 50 percent of your Social Security income
Add those amounts up and if youre under the threshold for your filing status, you wont be paying federal taxes on your benefit.
Even if youre above this threshold, however, you may not have to pay tax on your full benefit. You may pay taxes on only 50 percent of your benefit or on up to 85 percent of it, depending on your combined income.
- For individual filers:
- Combined income between $25,000 and $34,000, up to 50 percent of your benefit is taxable
- Combined income above $34,000, up to 85 percent of your benefit is taxable
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What Is Social Security Disability Insurance
Social Security Disability Insurance is a social insurance program funded by payroll taxes meant to help you if you become disabled. The programs administrator, the Social Security Administration , generally allows you to earn coverage benefits if you meet their definition of disabled and are unable to work for a year or more.
The Social Security Disability Insurance program provides modest though vital benefits to you if you have suffered a serious and long-lasting medical condition that meets Social Securitys strict definition of disability. As a result, you can receive benefits if you meet the eligibility requirements.
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Make Sure Youre Taking Your Maximum Capital Loss
If youve invested in stocks or bonds and have a loss on paper, you might want to sell and realize that loss so you can claim it as a tax deduction. The process is called tax-loss harvesting, and it can net you a sizable deduction from your income.
The tax code allows you to write off up to a net $3,000 each year in investment losses. A write-off first reduces any other capital gains that youve incurred throughout the year. For example, if you have a $3,000 gain on one asset but a $6,000 loss on another, you can claim a deduction for the full $3,000 net loss.
Any net loss beyond that $3,000 has to be carried forward to future years, at which point it can be used. And even if you cant realize the full value of that net loss, it can still make sense to realize some loss, especially if it pushes your Social Security benefit into the tax-free area.
Tax-loss harvesting works only in taxable accounts, not special tax-advantaged accounts such as an IRA.
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How Social Security Benefits Are Taxed
Social Security beneficiaries must pay federal income tax on a portion of their benefits if their income exceeds certain thresholds the portion of benefits that is taxable rises with income. Income for this purpose equals a taxpayers adjusted gross income plus tax-exempt interest, certain other tax-exempt income, and half of Social Security benefits this is referred to as modified AGI. A three-part formula applies:
- For individuals with modified AGI below $25,000 and couples with modified AGI below $32,000, no Social Security benefits are taxable.
- For individuals with modified AGI between $25,000 and $34,000 and couples with modified AGI between $32,000 and $44,000, up to 50 percent of benefits are taxable.
- For individuals with modified AGI over $34,000 and couples with modified AGI over $44,000, up to 85 percent of benefits are taxable.
For a detailed explanation of the tax calculation, see Appendix Table 1.
What Is Social Security
Social Security is a federal program that pays monthly benefits to retirees, surviving spouses and children, and disabled people. About 65 million Americans collect Social Security monthly.
The money for Social Security, as well as Medicare, comes from a tax that every working American pays. It’s a 7.65% tax on every paycheck that is matched by employers. Self-employed people cover both the employee and employer portions. That tax is levied on the first $147,000 of a worker’s income in the 2022 tax year.
So, while workers pay a tax to fund the Social Security program, other people are benefiting by collecting a monthly check. Those benefit checks are then often taxed as income, returning a portion of the money to the federal government.
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Tax Withholding And Estimated Tax Payments For Social Security Benefits
If you know in advance that a portion of your Social Security benefits will be taxed, it’s a good idea to have federal income taxes withheld from your payment each month. Simply fill out Form W-4V to request withholding at a rate of 7%, 10%, 12% or 22%, and then send the form to your local Social Security office.
If you don’t want to have taxes withheld from your monthly payments, you can make quarterly estimated tax payments instead. Either way, you just want to make sure you have enough withheld or paid quarterly to avoid an IRS underpayment penalty when you file your income tax return for the year.
Reportable Social Security Benefits
Iowa does not tax Social Security benefits. While Social Security benefits are excluded from income when computing tax, some Social Security benefits are included as income in determining whether a taxpayer has sufficient income to file an Iowa return, and are included as income for purposes of computing the alternate tax on line 39. NOTE: This also affects you if you are single and use the Tax Reduction Worksheet. The reportable Social Security benefit is calculated using the worksheet below and entered on Step 4 of the IA 1040.
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Taxing Social Security Benefits Is Sound Policy
Social Security beneficiaries with higher incomes pay income tax on part of their benefits. Those with incomes below $25,000 pay no tax on benefits, while those with the highest incomes pay tax on as much as 85 percent of their benefits. This arrangement is sound for several reasons:
- The substantial proceeds from taxing Social Security benefits are credited to the Social Security and Medicare trust funds, strengthening the programs financing.
- The taxation of benefits is broadly progressive, since people with low incomes pay nothing and the tax rate on benefits increases with income.
- As an earned benefit, Social Security should be subject to tax, like other earned benefits, such as employer pensions.
- Social Securitys tax treatment is more favorable than that of private defined-benefit pensions, primarily because of the protections for low-income beneficiaries.
Will You Owe Taxes On Your Social Security Benefits
As with most questions about taxes, the answer is “it depends.”
About 40% of people who get benefits pay income taxes on them, according to the Social Security Administration . That’s because their income in retirement exceeds limits set by tax rules and regulations.
Generally, if Social Security is your only retirement income, you won’t have to pay taxes on it. But if you have at least moderate income, you’ll most likely owe the government some money.
The good news is that while up to 85% of your benefits may be taxed at ordinary income rates, it’s never 100%. That’s considered tax-efficient compared with other retirement plans whose distributions may be fully taxable. In addition to the federal tax bite, 13 states also tax Social Security benefits using either the federal provisional income formula or their own.
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How To Calculate Your Social Security Income Taxes
If your Social Security income is taxable, the amount you pay will depend on your total combined retirement income. However, you will never pay taxes on more than 85% of your Social Security income.
Again, if you file as an individual with a total income thats less than $25,000, you wont have to pay taxes on your Social Security benefits in 2022. For the 2022 tax year , single filers with a combined income of $25,000 to $34,000 must pay income taxes on up to 50% of their Social Security benefits. If your combined income is more than $34,000, you will pay taxes on up to 85% of your Social Security benefits.
For married couples filing jointly, you will pay taxes on up to 50% of your Social Security income if you have a combined income of $32,000 to $44,000. If you have a combined income of more than $44,000, you can expect to pay taxes on up to 85% of your Social Security benefits.
If 50% of your benefits are subject to tax, the exact amount you include in your taxable income will be the lesser of either:
- half of your annual Social Security benefits OR
- half of the difference between your combined income and the IRS base amount
The example above is for someone whos paying taxes on 50% of their Social Security benefits. Things get more complex if youre paying taxes on 85% of your benefits. However, the IRS helps taxpayers by offering software and a worksheet to calculate Social Security tax liability.
Taxes On Retirement Income
In retirement, different kinds of income are taxed differently:
- Most interest on bank deposit accounts is taxed at the same federal income tax rate as the money you receive from paid work.
- Distributions from traditional 401s and IRAs are typically subject to the tax rates associated with your current marginal tax bracket.
- Dividends paid or gains from the sale of stocks are taxed at 0%, 15%, or 20%, depending on how long you’ve held the stock, your taxable income, and your tax filing status.
- Other incomesuch as qualified withdrawals from a Roth IRA, a Roth 401, or a health savings account are not subject to federal income taxation and do not factor into how your Social Security benefit is taxed.1
When the total income calculated under the combined income formula for Social Security is more than the threshold , up to 85 cents of every Social Security income dollar can be taxed.
So as you work with financial and tax professionals, consider the following 2 strategies.
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History And Rationale For Taxing Social Security Benefits
For more than four decades, Social Security benefits were not subject to income tax. The Treasury Departments rationale for not taxing Social Security benefits was that the benefits under the Act could be considered as gratuities, and since gifts or gratuities were not generally taxable, Social Security benefits were not taxable.
Former Social Security Commissioner Robert M. Ball long argued that, since Social Security is an earned benefit, it should be taxed like other earned benefits, such as employer pensions. Workers pay income tax on private pensions to the full extent that their benefits exceed their contributions, with no income thresholds.
As a leading member of the Greenspan commission on Social Security in 1982-83, Ball had an opportunity to promote this idea. The subsequent Social Security Amendments of 1983 provided that up to 50 percent of benefits would be taxable for beneficiaries with incomes above certain levels. A decade later, the Omnibus Budget Reconciliation Act of 1993 provided for the taxation of up to 85 percent of benefits for individuals with modified AGI above somewhat higher thresholds. The provision has since remained unchanged.
Social Security And Railroad Retirement Benefits
If your social security or railroad retirement benefits were taxed on your federal return, you may take a deduction for those benefits on your North Carolina individual income tax return. You may take this deduction because this income has already been included as part of your federal adjusted gross income and North Carolina does not tax this income. This deduction will increase your refund or decrease the amount you must pay.
Any social security benefits you received that are not included in your federal adjusted gross income cannot be deducted on your North Carolina return. If your federal adjusted gross income includes social security benefits, enter the taxable amount of social security benefits on Form D-400 Schedule S, Part B Deductions from Federal Adjusted Gross Income, Line 18. The total deductions from federal adjusted gross income entered on Form D-400 Schedule S, Line 38, also needs to be entered on Form D-400, Line 9.
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E Can High Implicit Tax Rates Be Avoided
Can these traps be avoided? The examples given are deliberately very simple. In practice, examples are often considerably more complex. However, a benefit like the rent benefit in the example always creates a trap for those who cannot afford to lose the benefit by increasing their earnings. One answer is for the allowance to be tapered. The allowance could be granted as a maximum of $150, with lower benefits to those with earnings in the trap area.
How can traps like this be avoided? The most important issue is to ensure that all tax, contribution, and benefit provisions are examined to ensure that trapping effects are identified and, if possible, minimized. Sometimes this can be done through the way a benefit is worked, rather than through a simple increase in value. For example, a taper based on net income rather than gross income keeps the total effective tax rate from exceeding 100 percent. This shows that a solution to a trap may lie in the way a benefit is paid rather than the way it is taxed or made subject to contribution liability. It may be that the nature of the benefit has to be changed. Alternatively, it may help to pay a larger benefit that is taxable rather than a smaller benefit that is exempt from tax, so that the beneficiary receives the same amount, but the distortions are avoided. There is no simple solution.171