Taxation of Social Security Benefits

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By Roy Lewis
March 15, 2002

Many of you have asked if your Social Security regular, disability, or survivor benefits will be subject to taxation. The answer is a definite maybe. Why maybe? Because the answer to the question is based on the amount of your Adjusted Gross Income (AGI) and the total amount of your Social Security benefits.

For a single person, your benefits will not be taxable unless the total of your modified AGI, plus one-half of your Social Security benefits, exceeds $25,000. If you are married and file a joint return, your modified AGI plus one-half of your Social Security benefits would need to exceed $32,000 before taxes kick in. If you are married filing a separate return, and you lived with your spouse, your threshold is actually zero, and your Social Security benefits may be taxable from dollar one.

You'll note that I use the term "modified" AGI above. For the purposes of the Social Security limitations, modified AGI generally means your AGI for regular tax purposes, plus any tax-exempt interest that you may have received. So, investing in tax-exempt bonds in your later years will not dodge the taxes that you may owe on your Social Security benefits.

Example: Jeff and June have regular income (such as interest income, dividend income, capital gain income, etc.) of $15,000. They also have tax-exempt interest income of $12,000. Together, they receive total Social Security benefits of $20,000. Since their modified AGI ($27,000) plus half of their Social Security benefits ($10,000) exceeds the $32,000 threshold, they will have to pay taxes on their Social Security benefits.

Okay, now that you know how to figure if any of your benefits are taxable, your next question just may be: How much of my benefits will be subject to taxes? Well, depending on your total income, it could be as much as 85% of your benefits.

But, only married people filing jointly with income that exceeds $44,000, or everyone else with income exceeding $34,000, will have 85% of Social Security benefits subject to taxes. (The threshold for married people filing separate returns remains zero, as described earlier.)

Example: Let's compute the taxable amount of Jeff and June's benefits. As noted above, they have provisional income of $37,000 (their modified AGI of $27,000 plus $10,000 that is one-half of their benefits). From this amount, they would subtract their threshold limit of $32,000. This gives them a result of $5,000.

The law says that you must include the lesser of 50% of your benefits ($10,000) or 50% of the above result ($2,500) as additional income subject to tax. So, for Jeff and June, they would be required to include $2,500 of their Social Security benefits as additional income subject to tax. This means that if Jeff and June are in the 15% marginal tax bracket, they'll pay about $375 (15% of $2,500) in taxes on their total benefits of $20,000.
Had Jeff and June's provisional income exceeded $44,000, up to 85% of their benefits could have been subject to taxation. But, those computations are way too complicated to deal with here. So, just know that as your income increases, so will the portion of your Social Security benefits that is subject to taxation.

And, please note that these rules also apply to Social Security disability and survivor benefits. Many people are under the mistaken impression that disability and/or survivor benefits are not subject to the rules regarding taxability of Social Security benefits in general. This is sadly not the case. So, if you are receiving Social Security disability or survivor benefits, you'll need to make sure whether any of your benefits will be subject to tax.

Also remember that, in the case of disability and survivor benefits, many of those benefits are paid to dependent children. While you may deposit those funds and use them for the benefit of the kids, those benefits will not be treated as your benefits for tax purposes. They are actually benefits paid to the children. If you don't believe that, check the form you receive from the Social Security Administration at the end of the year (Form SSA-1099). You'll receive separate statements for yourself and your children. And the kids' benefits will be reported under their separate Social Security numbers. So, whatever you do, don't include the kids' Social Security benefits in the computations you do to determine your taxable benefits.

If some of your Social Security benefits may be taxable, you really want to read IRS Publication 915 (found at the IRS website). Publication 915 gives you much more detail regarding the taxation of your Social Security benefits and provides a number of worksheets you can use to do your own computations.

Roy Lewis lives in a trailer down by the river and is a motivational speaker when not dealing with tax issues, and he understands that The Motley Fool is all about investors writing for investors. You can take a look at the stocks he owns as long as you promise not to ask him which stock to buy. He'll be glad to help you compute your gain or loss when you finally sell a stock, though.

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