If you’re getting close to retirement, you may wonder whether your Social Security benefits will be taxed. And if so, by how much?
It depends on your other income and your marital status. As much as 85% of your benefits could be taxed. (This doesn’t mean you pay 85% of your benefits back to the government in taxes. It means that you may be required to include up to 85% of your benefits in your income and be subject to your regular tax rates.)
Crunch the numbers
To determine how much of your benefits are taxed, first determine your other income, including certain items otherwise excluded for tax purposes (for example, tax-exempt interest). To this, add half of the Social Security benefits you received during the year. Now apply the following rules:
- If the calculated amount is below $32,000 ($25,000 for single taxpayers), none of your benefits are taxed.
- If the calculated amount exceeds $32,000 but isn’t more than $44,000, you will be taxed on 50% of the excess over $32,000, or half of the benefits, whichever is lower. If your calculated amount exceeds $44,000 you will be taxed on 85% of your benefits. ($34,000 for single taxpayers)
Here’s an example
For example, let’s say you and your spouse have $20,000 in taxable dividends, $2,400 of tax-exempt interest and combined Social Security benefits of $21,000. So, your income plus half your benefits is $32,900 ($20,000 + $2,400 + 1/2 of $21,000). You must include $450 of the benefits in gross income (1/2 [$32,900 − $32,000]).
If your combined Social Security benefits were $5,000, and your income plus half your benefits were $40,000, you would include $2,500 of the benefits in income: one-half ($40,000 − $32,000) equals $4,000, but half the $5,000 of benefits ($2,500) is lower, so the lower figure is used.
Important to note: If you aren’t paying tax on your Social Security benefits now because your income is below the threshold, or you’re paying tax on only 50% of those benefits, an unplanned increase in your income can have a triple tax cost. You’ll have to pay tax on the additional income, you’ll 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.
For example, this situation might arise if you receive a large distribution from an IRA during the year or you have large capital gains. Careful planning can help you avoid this negative tax result. You might be able to spread the additional income over more than one year, or take your needed cash from an account other than an IRA account. For example, if you have a stock showing only a small gain or stock with a gain that can be offset by a capital loss on other investments you can receive the cash needed with lower income to report.
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 can increase your withholding from other sources of income or start making estimated tax payments. Reach out to a KraftCPAs professional to see how these rules could apply to your benefits.