During your working days, you pay Social Security tax in the
form of withholding from your salary or self-employment tax. And when you start
receiving Social Security benefits, you may be surprised to learn that some of
the payments may be taxed.
If you’re getting close to retirement age, you may be wondering
if your benefits are going to be taxed. And if so, how much will you have to
pay? The answer depends on your other income. If you are taxed, between 50% and
85% of your payments will be hit with federal income tax. (There could also be
state tax.)
Important: This
doesn’t mean you pay 50% to 85% of your benefits back to the government in
taxes. It means that you have to include 50% to 85% of them in your income
subject to your regular tax rates.
Calculate provisional income
To determine how much of your benefits are taxed, you must
calculate your provisional
income. It starts with your adjusted gross income on your tax
return. Then, you add certain amounts (for example, tax-exempt interest from
municipal bonds). 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 provisional income. Now
apply the following rules:
- If you file a joint tax return and your provisional
income, plus half your benefits, isn’t above $32,000 ($25,000 for single
taxpayers), none of your Social Security benefits are taxed.
- If your provisional income is between $32,001 and
$44,000, and you file jointly with your spouse, you must report up to 50%
of your Social Security benefits as income. For single taxpayers, if your
provisional income is between $25,001 and $34,000, you must report up to
50% of your Social Security benefits as income.
- If your provisional income is more than $44,000, and
you file jointly, you must report up to 85% of your Social Security
benefits as income on Form 1040. For single taxpayers, if your provisional
income is more than $34,000, the general rule is that you must report up
to 85% of your Social Security benefits as income.
Caution: 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 significant tax cost. You’ll have
to pay tax on the additional income, you’ll also have to pay tax on (or on more
of) your Social Security benefits, and you may get pushed into a higher tax
bracket.
For example, this might happen if you receive a large retirement
plan distribution during the year or you receive large capital gains. With
careful planning, you might be able to avoid this tax result.
Avoid a large tax bill
If you know your Social Security benefits will be taxed, you may
want to voluntarily arrange to have tax withheld from the payments by filing a
Form W-4V with the IRS. Otherwise, you may have to make estimated tax payments.
Contact us to help you with the exact calculations on whether
your Social Security will be taxed. We can also help you with tax planning to
keep your taxes as low as possible during retirement.
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