Most people are well aware that their wages are taxed. But there are some other income sources you may be much more surprised to find Uncle Sam taking a cut of. Here are three of them.
1. Social Security benefits
Social Security benefits aren't taxed for every retiree, but around 50% of seniors pay federal income tax on them. And more will in the future since the income threshold at which benefits become taxable isn't indexed to inflation.
Retirees could owe federal tax on up to 50% of benefits once their countable income hits $25,000 as a single filer or $32,000 as a married joint filer. Once countable income reaches $34,000 for single filers or $44,000 for married joint filers, up to 85% of benefits will become subject to federal tax. Countable income is defined to include half of all Social Security income along with all other taxable income and some nontaxable income.
There are also 13 states that tax Social Security benefits, although the rules differ depending on where you live.
This may come as a shock, since you've earned your benefits with payroll taxes throughout your career. But federal taxes can often be avoided by investing in Roth accounts for retirement so your distributions aren't considered part of your countable income. And you won't have to pay state taxes if you retire to a state that doesn't assess them on Social Security.
2. Unemployment benefits
If you're receiving unemployment benefits, you may not expect to be taxed on them; it makes little sense for the government to give you money, only to assess taxes on it.
But unemployment benefits are considered taxable income by the IRS, and depending on where you live, your state may also want to tax this money, too. You'll be taxed at your ordinary income tax rate by the federal government, although you won't owe payroll taxes.
It's important you realize these benefits are taxable, as you'll need to either have taxes withheld from them or submit quarterly estimated tax payments to avoid penalties for not paying taxes on income as it's received
3. Pension income
If you did not personally invest in your pension, payouts from it are fully taxable by the federal government. That's the case if you didn't contribute any money to your pension, your employer didn't withhold contributions from your salary, and all the contributions to your pension were tax-free.
Your pension could be partly taxable if you did make some contributions; you won't be taxed on any part of your payouts that are simply classified as a return of the money you invested.
Most states also tax your pension as well, at least under some circumstances, although a minority of jurisdictions allow you to receive this money tax-free.
You may not expect this since you've worked your entire career to earn your pension, but you'll need to make sure taxes are being withheld or are otherwise paid on time to avoid penalties.
It can be painful to discover you'll be taxed on your pension, Social Security, or unemployment benefits. But you need to make certain you're fulfilling your obligations to pay all revenue due. So plan for these costs in your budget to avoid a very unpleasant surprise when tax day rolls around.