Summer seems to be the tax planning time around the office. Generally a client mentions retirement or starting to draw Social Security when I prepare their taxes and I suggest getting together to do some planning. I have seen too many times when the client gets a nasty surprise the 1st time they do “retirement” taxes. The big culprit is usually Social Security taxability. It’s not something SSA mentions when a taxpayer starts drawing their Social Security. And, surprisingly, it’s not something “friends” warn them about either.
Social Security can be taxable. It depends of the income on the return. Basically, if half of the Social Security received and all the rest of the income on the return is less than $32,000 for a couple filing jointly, $25,000 for everyone else (one exception), then the Social Security is not taxable. Above that, taxability phases in up to a maximum of 85% taxability. Since this is the tax code we’re talking about, the actual calculations are not as simple as it sounds. There is some excluded income that has to be added into the calculation. And if the taxpayer is filing Married Filing Separate but lived even one day with their spouse, they go to 85% taxability and skip the phase in. You get the picture.
There are two special problems with taxability of Social Security benefits. The first is that they can be taxed on more than was actually received. The taxable amount is figured on the total amount credited to the taxpayer and that includes attorney fees and Workman’s’ Comp pay back. I have also seen where gambling winnings have triggered taxable Social Security. While the client may have losses to offset gambling income, they are still stuck paying taxes on the Social Security. Also, if you receive a lump sum that includes back years benefits, there are some special calculations that might reduce the taxability. Please talk to your tax preparer. My big problem with taxing Social Security is there has been no adjustment for inflation. When I started preparing taxes in 1988, I seldom saw taxable Social Security. Benefits were much lower and few retirees worked or had large pensions to trigger taxability. Now, it is rare to not have taxable Social Security. I’d like to see the thresholds tied to inflation but with the deficit and other tax issues, I don’t see this happening.
If it looks as if you will have taxable Social Security, you might want to set up withholding from SSA, up the withholding from another source or make estimate payments to keep from an underpayment of estimated tax penalty. Yes, you can have Social Security withhold for Federal. It’s a set percentage; 7%, 10% or 15%, your choice. It many not cover all the tax but it’s a start.
The good news is that many states don’t tax Social Security benefits. In Kansas, if the Federal Adjusted Gross Income is less than $75,000, the taxable Social Security is subtracted from the Federal income. Unfortunately, if the income is above $75,000, there is no deduction. Oklahoma, however, allows taxpayers to deduct all the taxable Social Security no matter how much income is involved. Check with your state for their policy.
Retirement should be a time of relaxation and not stress about taxes. The best idea is to check with your tax professional about what you can do to protect yourself from tax surprises. And make sure that they are taking taxable Social Security into consideration. If they aren’t, maybe it’s time to look for someone new.