Tax season has come and gone, and American taxpayers finally have the results of what they saved -- or didn't save -- from tax reform. With so many different factors at play, there were inevitable winners and losers from the tax law changes, with the actual savings or extra tax liability depending on your individual situation.
Nevertheless, one can make some general conclusions about the impact of tax reform, and many retirees getting Social Security were disappointed to find that a portion of their benefits continued to be subject to federal taxation. Yet even if the number of retirees seeing a portion of their benefits taxed stayed relatively constant, there were still considerable savings in the amount of tax those Social Security recipients had to pay.
Why some seniors are upset
One reason why many older Americans believe that the tax cuts left them out is that reform provisions didn't make any changes to the rules governing how much of their Social Security income gets taxed. Under laws prevailing both before and after tax reform, as much as 50% to 85% of Social Security benefits can get added to taxable income in order to calculate tax liability, depending on how much money a taxpayer makes both from Social Security and from any other sources of income.
Image source: Getty Images.
A study from the Senior Citizens League confirmed that because of the lack of changes to the Social Security taxation provision, just about the same proportion of households reported having a portion of their benefits subject to tax. Since 2015, the average number of households paying taxes on Social Security fell just a percentage point, from 51% to 50%.
However, the Senior Citizens League didn't reveal the amount of additional tax on the portion of benefits included in taxable income. Thanks to higher standard deductions and reduced tax rates, many Social Security recipients got a significant tax break in 2018 -- even if their Social Security remained taxable.
What tax reform did for Social Security recipients
As a simple example, consider a single retiree with a comfortable total income of $60,000 a year. We'll assume that this retiree gets $2,000 in monthly Social Security retirement benefits along with another $3,000 in regular income from a private pension and a retirement nest egg, and that the standard deduction gives the retiree the most tax savings.
You can see below how the situation works out under old law and after tax reform.
|
Item |
2017 Tax Year |
2018 Tax Year |
|---|---|---|
|
Total income |
$60,000 |
$60,000 |
|
Gross income for tax purposes |
$52,400 |
$52,400 |
|
Standard Deduction |
($7,900) |
($13,600) |
|
Personal Exemption |
($4,050) |
N/A |
|
Taxable Income |
$40,450 |
$38,800 |
|
Tax |
$5,851 |
$4,476 |
Calculations by author based on IRS rules.
In this example, tax reform saved this relatively well-off retiree $1,375 in taxes, or nearly a quarter of the previous tax bill. The bulk of the savings came from the fact that most of the retiree's income got taxed at lower tax rates of 12% and 22% rather than the 15% and 25% rates that applied under old law. This 3-percentage-point difference applied to save not only almost $500 on the $16,400 in Social Security that was subject to tax but also another $875 or so from the taxes on pension and investment income.
A higher standard deduction also served to make less of the retiree's income taxed in the final tax bracket. About $2,500 in the retiree's 2017 income was subject to tax at 25%, while only $100 was subject to the 22% tax rate in 2018. Even with the elimination of personal exemptions, a higher standard deduction played a key role in producing that tax savings.
Don't rely on generalizations
There are a number of factors that could lead to different results in certain individual cases. They include the following:
- Social Security recipients who itemized deductions in past years might not have seen any benefit from larger standard deductions -- or might actually have seen their itemized deductions drop under tax reform.
- Those with more modest incomes might not have seen as much benefit from lower tax rates as the taxpayer in the example above.
- Certain types of income, such as qualified dividend income on stocks, got taxed at lower rates both before and after tax reform, producing no incremental benefit for retirees in 2018.
Yet even with no changes in Social Security taxation provisions, many recipients did get rewards from tax cuts. That won't make advocates less zealous in their efforts to make Social Security benefits tax-free, but it could make you feel better about tax reform -- especially if you were one of the many who saw savings.
