How Social Security Benefits are Taxed
After years of hard work and seeing that large deduction from your income called FICA (or SECA if you’re self employed), you’ve finally made it to begin collecting your Social Security benefits. The checks start rolling in but then you notice something when you file your taxes. Your Social Security benefits are taxable! Is that right?
Unfortunately, yes. A lesser-known aspect to those yet to claim is their potential taxability. Understanding how Social Security benefits are taxed can help beneficiaries manage their finances more effectively and avoid unexpected tax liabilities. This article will delve into the specifics of Social Security taxation, including the conditions under which benefits are taxed, how to calculate taxable amounts, and strategies for minimizing tax burdens.
How to Calculate Taxes on Social Security
Social Security taxes aren’t a separate tax. Instead, Social Security benefits can become more taxable or less taxable which then increases (or decreases) your federal taxable income. This taxable income is then taxed at your ordinary federal income tax rates.
The taxability of Social Security benefits depends on a beneficiary’s total income and filing status which involves two calculations:
- Calculate Provisional Income
- Apply the Provisional Income to a Formula
Step 1) How to Calculate Provisional Income
Provisional Income is just a unique combination of income sources based on your personal situation. Provisional income is only used in the the calculation for Social Security taxation and not anywhere else in the tax code.
Provisional Income includes:
- Adjusted Gross Income (AGI): AGI is found on your tax return as a specific line item. It encompasses all taxable income such as wages, dividends, interest, and capital gains.
- Non-Taxable Interest: Interest earned from tax-exempt bonds.
- 50% of your Social Security Benefits: 50% of the total annual Social Security benefits received. If a couple are both collecting benefits, this would be the total.
Provisional Income Formula = AGI + Non-Taxable Interest + 50% of Social Security Benefits
Step 2) Apply Provisional Income to a Formula
Once you know your provisional income, the IRS has set a table for determining how much of your benefits are taxable. This formula is broken down by filing status:
Single Filers
- Up to $25,000: No Social Security benefits are taxed.
- $25,000 – $34,000: Up to 50% of Social Security benefits may be taxable.
- Over $34,000: Up to 85% of Social Security benefits may be taxable.
Married Filing Jointly
- Up to $32,000: No Social Security benefits are taxed.
- $32,000 – $44,000: Up to 50% of Social Security benefits may be taxable.
- Over $44,000: Up to 85% of Social Security benefits may be taxable.
Married Filing Separately
Generally, up to 85% of Social Security benefits may be taxable, regardless of provisional income, especially if the spouses lived together at any time during the tax year.
In case you are wondering, these thresh holds are not currently adjusted for inflation.
The formula applies as follows:
- If the provisional income is below the first thresh hold, your social security benefit is not taxable and you can stop there.
- If it is above the thresh hold, you calculate the excess above the lower end of the thresh hold and multiply that by either 50% or 85%.
Examples
Here are a few examples of the formula for a Married Filing Jointly:
Below Thresh hold
AGI = 15,000
Non-Taxable Interest = 0
Social Security Benefit = 20,000
Provisional Income = 15,000 + 0 + 10,000 (20,000 x .5) = $25,000
Provisional Income is less than $32,000 so the $20,000 of social security benefits are not taxable!
Final Taxable Benefits = 0
Non-Taxable Benefits = $20,000
Middle Thresh hold
AGI = 30,000
Non-Taxable Interest = 0
Social Security Benefit = 20,000
Provisional Income = 30,000 + 0 + 10,000 (20,000 x .5) = 40,000
Excess over first thresh hold = 40,000 – 32,000 = 8,000
Final Taxable Benefits = 8,000 x .5 = 4,000
Non-Taxable Benefits = 20,000 – 4,000 = 16,000
Above Thresh Hold
AGI = 35,000
Non-Taxable Interest = 2,000
Social Security Benefit = 30,000
Provisional Income = 35,000 + 2,000 + 15,000 (30,000 x .5) = 52,000
Excess over first thresh hold = 44,000 – 32,000 = 12,000
Taxable Benefits = 12,000 x .5 = 6,000
Excess over second thresh hold = 52,000 – 44,000 = 8,000
Taxable Benefits = 8,000 * .85 = 6,800
Final Taxable Benefits = 6,000 + 6,800 = 12,800
Non-Taxable Benefits = 20,000 – 12,800 = 7,200
As a final example, the below chart illustrates how Social Security benefits become taxable as other income is added in. The scenario below begins with Social Security up to $30,000 in benefits and then ordinary income on top of that up to $70,000 in income.
How Do You Lower Social Security Taxation?
To lower your Social Security taxation, you have to find ways to lower your Adjusted Gross Income (AGI). Here are a few ways to do so:
- If you are still working, contribute to a pre-tax retirement plan or Traditional IRA.
- Withdraw income from Tax-Free accounts (Roth IRA’s), or Basis in taxable accounts.
- If eligible, contribute to a Health Savings Account (HSA). See A Healthy Investment: Discover the Surprising Benefits of Health Savings Accounts – Gilbert Wealth
- Tax Loss Harvest
- If eligible, utilize Qualified Charitable Distributions for charitable giving.
- Ensure deductions such as Student Loan Interest, Educator Expenses, Business Expenses, and Rental Property Expenses are fully accounted for.