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Do I Have To Pay Taxes On Social Security Benefits?

by | Sep 9, 2021 | Federal Taxation |

 

Many Americans wonder if the Social Security benefits they receive from the U.S. government as a result of retirement age, disability, or survivorship will be subject to federal or state taxes.  The answer: it depends.  The amount of tax you pay (if any) is generally based on what your total income is from all sources during the tax year.

The Internal Revenue Code provides the following calculations for taxpayers to determine how much of their Social Security benefits are subject to federal income taxes:

  • First, the taxpayer needs to calculate their “modified adjusted gross income”. This amount is the total adjusted gross income from Social Security, wages, self-employment earnings, interest, dividends, required minimum distributions from retirement accounts (e.g. IRAs) and all other taxable income PLUS any tax-exempt interest earned (this is still not taxed, but is included in this calculation).  26 U.S.C. 86(b)(2).
  • Second, the taxpayer needs to determine which “base amount” applies to them based on their status. Base amount means one of the following:
    • $25,000.00 for single filers, head of households or qualifying widowers. 26 U.S.C. §86(c)(1)(A).
    • $32,000.00 for a joint return. 26 U.S.C. §86(c)(1)(B).
    • $0.00 for a taxpayer who is married filing separately AND does not live apart from the spouse during the tax year. 26 U.S.C. §86(c)(1)(C).
  • Third, the taxpayer needs to determine which “adjusted base amount” applies to them based on their status. Adjusted base amount means one of the following:
    • $34,000.00 for single filers, head of households or qualifying widowers. 26 U.S.C. §86(c)(2)(A).
    • $44,000.00 for a joint return. 26 U.S.C. §86(c)(2)(B).
    • $0.00 for a taxpayer who is married filing separately AND does not live apart from the spouse during the tax year. 26 U.S.C. §86(c)(2)(C).

Next, the taxpayer determines how much of the Social Security benefits are taxable based on how much their modified adjusted gross income exceeds the base amount and/or the adjusted base amount.

  • If the taxpayer’s modified adjusted gross income is EQUAL TO OR LESS than the base amount, then 0% of his or her Social Security benefits are taxable.
  • If the taxpayer’s modified adjusted gross income is GREATER than the base amount but EQUAL TO OR LESS than the adjusted base amount, then he or she is taxed in an amount equal to the lesser of:
    • 50% of the Social Security benefits received during the tax year. 26 U.S.C. §86(a)(1)(A).
    • OR 50% of the amount of modified adjusted gross income that exceeded the base amount. 26 U.S.C. §86(a)(1)(B).
  • If the taxpayer’s modified adjusted gross income is GREATER than the adjusted base amount, then the amount that is included in gross income is equal to the lesser of:
    • 85% of the Social Security benefits received during the tax year. 26 U.S.C. §86(a)(2)(B).
    • OR the SUM of 85% of the amount of modified adjusted gross income that exceeded the adjusted base amount PLUS THE LESSER OF 50% of the Social Security benefits received during the tax year OR the amount equal to 50% of the difference between the base amount and the adjusted base amount of the taxpayer. 26 U.S.C. §86(a)(2)(A).

These rules for determining how much of the Social Security benefits are taxable also apply to spousal benefits (with base amount and adjusted base amount calculated as a single taxpayer at $25,000.00 and $34,000.00 respectively) and also applies to Social Security Disability Benefits (SSDI).  If a child receives Social Security survivor benefits, then the taxable amount is determined by the child’s total income and is not included in the parent or guardian’s income.

These calculations DO NOT apply to Supplemental Security Income (SSI), which is needs-based program for people who are aged, disabled or blind.  SSI benefits are not taxable.

If your Social Security benefits are taxable, then you must report these amounts on Form 1040 or Form 1040-SR.  The taxpayer will receive Form SSA-1099 from the Social Security Administration every year showing the net benefits (total amount from box 5) that may have to be included on your federal or state tax return.

In 2021, the estimated average Social Security retirement benefit is $1,543.00 per month, or $18,516.00 per year.  Here are some examples of how the taxable amount is calculated in real life:

  • John is retired and single. In 2021, he receives Social Security benefits totaling $8,000.00, a fully taxable pension of $16,000.00, $6,000.00 of wages from a part-time job, and dividends from stocks in the amount of $500.00.  His total modified adjusted gross income in 2021 is $30,500.00.  John’s income exceeds the base amount of $25,000.00 but is less than the adjusted base amount of $34,000.00.  This means that John must pay taxes on THE LESSER OF 50% of his Social Security benefits ($4,000.00) OR the amount of modified gross income that exceeded the base amount ($5,500.00).  John’s total taxable Social Security benefits are $4,000.00.
  • Mike and Molly file a joint tax return as a married couple. Mike is retired and receives $18,000.00 in pension and $7,000.00 in Social Security benefits.  Molly has a part time job where she earned $5,000.00 in wages and a savings account at the bank that earned $150.00 in interest.  Their total modified adjusted gross income in 2021 is $30,150.00.  Their modified adjusted gross income is less than the base amount of $32,000.00 for joint filers.  This means that 0% of Mike’s Social Security benefits are taxable.
  • Fred is retired and files his taxes as head of household to support grandchildren under his care. In 2021, he receives $12,000.00 in Social Security benefits, $13,000.00 from a fully taxable pension, $5,000.00 in taxable interest income, and $6,000.00 from self-employment income in providing consulting services.  His total modified adjusted gross income in 2021 is $36,000.00.  His income exceeds both the base amount of $25,000.00 and the adjusted base amount of $32,000.00.  This means that Fred must pay taxes on THE LESSER of 85% of his Social Security Benefits ($10,200.00) OR the sum of 85% of his modified adjusted gross income that exceeded the adjusted base amount ($3,400.00) plus either the lesser of 50% of Social Security benefits received or 50% of the difference between the base amount and the adjusted base amount (the lesser being $6,900.00).  This means that Fred’s total taxable Social Security benefits are $6,900.00.
  • Anna and Charles are legally married and live together. Due to concerns about Charles lying on his taxes, Anna opts to file a return as married filing separately.  Anna is retired and earns $7,000.00 from Social Security benefits and $8,000.00 from pension benefits, totaling $15,000.00.  However, since Anna is married filing separately and lives with her spouse, her base amount and adjusted base amount is $0.00.  This means that Anna must pay taxes on the LESSER of 85% of her Social Security benefits ($5,950.00) OR the sum of 85% of her modified adjusted gross income that exceed the adjusted base amount ($12,750.00) plus either the lesser of 50% of Social Security benefits received or 50% of the difference between the base amount and the adjusted base amount (the lesser being $0.00).  Anna’s total taxable Social Security benefits are $5,950.00.
  • Max and Gina are legally married and living apart, but are not electing to divorce so Gina will still continue to receive Max’s insurance benefits. Max receives Social Security benefits in the amount of $9,000.00 and another $8,000.00 from wages at a part-time job, totaling $17,000.00 of modified adjusted gross income.  Although Max is electing to file married but separately, his base amount is still $25,000.00 because he has lived apart from Gina during the entire tax year.  Congress recognized that seniors would not elect to divorce even when no longer living as husband and wife so that they could still receive health insurance and survivor benefits.  Therefore, the married filing separately penalty doesn’t apply in this instance.  His modified gross income is less than the base amount.  Therefore, 0% of Max’s Social Security benefits are taxable.

Are Social Security benefits taxable on state income taxes?  It depends on which state you live in.  Currently, 13 states tax some or all of their resident’s Social Security Benefits: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia.  This means that there are 37 states where Social Security benefits are not taxed in any way, shape or form (including Michigan).

The manner in which Social Security benefits are taxed should factor into your retirement plans.  Here are some strategies to reduce or eliminate the amount of taxes you pay:

  • Limit Taxable Income During Retirement: If you choose to undertake part-time during retirement, limit your hours or salary to an amount that keeps your overall taxable income under the base amount or adjusted base amount.
  • Consider Roth IRAs Or Other Tax-Free Retirement Income: If you make contributions to Roth IRAs, the distributions from these accounts are tax-free because you had already paid the income taxes at the time of contribution.  These distributions made during retirement are not counted as taxable income and may help you stay under the base amount.
  • Move To One Of The 37 States That Does Not Tax Social Security: Michigan starts to look a lot better as you get older.

If you have further questions about the taxation of Social Security benefits or need additional legal assistance, then do not hesitate to contact the experienced attorneys at Kershaw, Vititoe & Jedinak PLC for assistance today.

 

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