No one wants to pay any more tax than they have to. For those who rely on Social Security for help making ends meet, every penny of their benefits is important. That's why so many people are shocked to learn that under some circumstances, their Social Security benefits can be subject to income tax -- effectively forcing them to give back from their precious monthly checks.
Many people have looked forward to the tax reform efforts that took effect at the beginning of 2018 as a possible way to fix some of their perceived problems with the tax system. Unfortunately, tax reform didn't have a direct effect on the taxation of Social Security, and even the parts of the legislation that affected Social Security taxation directly won't have as big of a positive impact as many might hope.
Why retirees had to pay tax on Social Security in the first place
Social Security wasn't treated as taxable income until the early 1980s, when another reform effort changed the rules on taxation of benefits. Because Social Security was running into financial trouble, lawmakers agreed to look at ways to raise revenue in order to help pay for the program.
Image source: Getty Images.
The decision that Washington eventually made was to create a test based on income, so that only some of those getting Social Security benefits would end up having to pay extra income tax. How the test works is that you take your total income from most sources other than Social Security and then add in 50% of your benefits for the year. So if you're still working, then your job income gets considered, and those with investments have to include their interest and dividends in the mix. Pension income also gets included if you're fortunate enough to receive payments from an employer.
If your income under that calculation is larger than certain thresholds, then at least a portion can be subject to tax. The table below includes two thresholds: one that applies to make up to half of your benefits subject to tax, and another above which up to 85% of your Social Security can end up having to get included in your taxable income.
|
Filing Status |
50% Taxation Threshold on Social Security |
85% Taxation Threshold on Social Security |
|---|---|---|
|
Single, Head of Household, Qualifying Widow(er) |
$25,000 |
$34,000 |
|
Married Filing Jointly |
$32,000 |
$44,000 |
Data source: IRS.
How tax reform affected Social Security taxation
Unfortunately, tax reform didn't change anything directly related to taxing Social Security. The numbers in the table above are exactly the same as they were before the latest changes to the tax laws, and so the same basic rules apply.
However, it's important to understand that you don't always have to include exactly 50% or 85% of your Social Security as income. The "up to 50% or 85%" refers to the complicated calculations that go into figure out exactly how much of your benefits are taxable. Using a Social Security income tax calculator is a great way to keep things as simple as possible.
In addition, tax reform's other provisions did have some indirect impacts on taxing Social Security benefits. With reductions in the tax rates that individual taxpayers pay, the net tax you'll owe on any benefits included in income could be less than they'd be under previous law. Higher standard deductions might have enough of a positive impact to wipe out any tax from including your benefits in your taxable income.
Be tax smart as a retiree
Tax reform didn't bring any great answers for retirees facing taxes on their Social Security benefits. But by knowing how the taxable amount is calculated, you can at least be ready when the tax man comes calling -- and if you can control your other sources of income, then you can make smarter decisions about how to manage your finances to minimize any tax impact from Social Security.
