Taxation of Social Security Benefits

Social Security benefits are taxed depending on your other income. In the worst-case scenario, 85% of your benefits would be taxed. This does not mean you pay 85% of your benefits back to the government in taxes, but you would include 85% of them in your income subject to your regular tax rates.

To determine how much of your benefits are taxed, you must 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 jointly. 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:

• If your income plus half your benefits is not above $32,000 ($25,000 for single taxpayers}, none of your benefits are taxed.
• If your income plus half your benefits exceeds $32,000 but is not more than $44,000, you will be taxed on (1) one half of the excess over $32,000, or (2) one half of the benefits, whichever is lower.

For single taxpayers, substitute the following for the above

• If your income plus half your benefits exceeds $25,000 but is not more than $34,000, you will be taxed on (1) one half of the excess over $25,000, or (2) one half of the benefits, whichever is lower.

If your income plus half your benefits exceeds $44,000 ($34,000 for single taxpayers), the computation in many cases grows far more complex. Generally, however, unless your income plus half your benefits is fairly close to $44,000 ($34,000 for single taxpayers), if you fall into this category, 85% of your Social Security benefits will be taxed.

Caution: If you are not paying tax on your Social Security benefits now because your income is below the above floor, or are paying tax on only 50% of those benefits, an unplanned increase in your income can have a triple tax cost. You will have to pay tax (of course) on the additional income, you will also 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 that are taxed), and you may get pushed into a higher marginal tax bracket. This situation might arise, for example, when you receive a large distribution from a retirement plan (such as an IRA) during the year or have large capital gains. Careful planning might be able to avoid this stiff tax result. For example, it may be possible 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 whose gain can be offset by a capital loss on other shares.

If you should need a large amount of cash for a specific purpose, please contact us before liquidating any assets so we can determine what your additional tax cost will be. 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 estimated tax payments.

If you would like us to run some specific numbers for you, or if you would like to discuss this matter further, please call.