Are Social Security Benefits Taxable? If So, Why?

Originally published in the Pacific Grove Hometown Bulletin

October 5, 2011

If you answered both “No,” and “Partially,” you are correct.  This seemingly simple question actually requires a full page of number crunching to determine the correct answer on your tax returns and will result in anywhere from zero to 85 percent being taxable.  If you go to my website http://www.tlongcpa.com/Financial-Tools and look in the income section there is a calculator that will do it for you!

Otherwise, below is a quick rule of thumb to determine where you fall on the tax ladder.  Stick this in your Social Security file.

First, take half the Social Security benefits you earned for the year and add to that all your other income including tax exempt interest (Add back certain income exclusions such as foreign income and adoption benefits).  We will call this modified income.

“No”

If your modified income is less than $32K and you are married filing joint (MFJ) then none of your Social Security will be taxable.  For everyone else, if your modified income is under $25K, then nothing will be taxable (exception – married filing separate and lived with spouse will always result in 85 percent of all Social Security benefits taxed regardless of other income).

“Partially”

If you do not want to do much head scratching and you want to estimate conservatively, here is my advice: If your modified income is between $32K and $44K as MFJ ($25K-$34K for everybody else), assume 50 percent of your total Social Security benefits are taxable.  If over those ranges, assume 85 percent of your total benefits are taxable.

If you want to be a pencil pushing tax hero here is what you do: If your modified income is between $32K and $44K as married filing joint ($25K-$34K for everybody else), 50 percent of the amount above $32K MFJ ($25K others) is the taxable amount of your Social Security benefits, capped at 50 percent of your Social Security benefits.  If your modified income is above those ranges, then your taxable Social Security benefits will be the lesser of A) 85 percent of your Social Security benefits OR B) 85 percent of your modified income above $44K MFJ, ($34K others) plus the lesser of 1) $6,000 MFJ ($4,500 others) or 2) 50 percent of your Social Security benefits.

Why is it taxed?

Most people want to know why the government taxes Social Security benefits, especially considering that you already paid income taxes on your Social Security contributions through the years.  To an extent, Social Security benefits are double taxed as a result.  We do need to remember, however, that Social Security is not just a retirement plan, but includes Medicare Parts B and D, disability, survivor’s benefits and many other social programs we may benefit from if needed.  Prior to 1983, Social Security benefits were not taxed.  In the late 1970s and early 1980s the government realized the system would soon be bankrupt because of added promises and demographics, so laws were passed to reform Social Security, including taxation of benefits.  Hmmm.  Kind of sounds like the same debate we are having again…  However you slice it, the bottom line is that it is not sustainable in its current form and we will have to cut benefits, raise taxes, or go further in debt.  I surmise it will be a combination of all three.

There may be a few other circumstances and specific rules that affect you, and you should consult with a qualified tax professional regarding your tax situation if you need an exact answer.  Prior articles are republished on my website at www.tlongcpa.com/blog.

IRS Circular 230 Notice: To the extent this article concerns tax matters, it is not intended to be used and cannot be used by a taxpayer for the purpose of avoiding penalties that may be imposed by law.

Travis H. Long, CPA is located at 706-B Forest Avenue, PG, 93950. He can be reached at 831-333-1041.

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