Some people who begin claiming Social Security benefits are surprised to find out they’re taxed by the US Federal Government on the amounts they receive.
If you’re wondering whether you’ll be taxed on your Social Security benefits, the answer is: It depends.
The taxation of Social Security benefits depends on your other income. If your income is high enough, between 50% and 85% of your benefits could be taxed.
Figuring your income.
To determine how much of your benefits are taxed, first determine your other income, including certain items otherwise excluded for tax purposes (for example, tax-exempt interest). Add to that the income of your spouse if you file a joint tax return. To this, add half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your total income plus half of your benefits.
Now apply the following rules:
Rule n. 1:
If your income plus half your benefits isn’t above $32,000 ($25,000 for single taxpayers), none of your benefits are taxed.
Rule n. 2:
If your income plus half your benefits exceeds $32,000 but isn’t more than $44,000, you will be taxed on one half of the excess over $32,000, or one half of the benefits, whichever is lower.
Example n. 1.
Let’s say you and your spouse have:
$20,000 in taxable dividends;
$2,400 of tax-exempt interest;
$21,000 of combined Social Security benefits.
So, your income plus half your benefits is $32,900:
$20,000 + $2,400 +½ of $21,000.
With this situation, your Social Security benefits will be taxed on $450, as this is the result of: ½ ($32,900 − $32,000).
Example n. 2.
Let’s say you and your spouse have:
$22,500 in taxable dividends;
$15,000 of tax-exempt interest;
$5,000 of combined Social Security benefits.
So, your income plus half your benefits is $40,000:
$22,500 + $15,000 +½ of $5,000.
With this situation, your Social Security benefits will be taxed on $2,500, as:
½ ($40,000 − $32,000) equals $4,000, but half the $5,000 of benefits ($2,500) is lower, and the lower figure is used.
What happens if your other income increase?
If you aren’t paying tax on your Social Security benefits now because your income is below the floor, or you’re paying tax on only 50% of those benefits, an unplanned increase in your income can have a triple tax cost. You’ll have to pay tax on the additional income, you’ll have to pay tax on (or on more of) your Social Security benefits (since the higher your income the more of your Social Security benefits are taxed), and you may get pushed into a higher marginal tax bracket.
For example, this situation might arise if you receive a large distribution from an IRA during the year or you have large capital gains.
Careful planning might avoid this negative tax result. You might be able to spread the additional income over more than one year, or liquidate assets other than an IRA account, such as stock showing only a small gain or stock with gain that can be offset by a capital loss on other shares.
Withholding,
If you know your Social Security benefits will be taxed, you can voluntarily arrange to have the tax withheld from the payments by filing a Form W-4V. Otherwise, you may have to make quarterly estimated tax payments.
Keep in mind that most states do not tax Social Security benefits, but 12 states do tax them.
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