As we listen to the candidates’ tax plans there is one tax reform idea that I am sure we won’t hear about; taxing Social Security. That is, doing something to reduce the tax on Social Security. A little honesty here; this is a pet peeve of mine. I understand the idea behind the taxability but it bothers me that Congress set up the rules without regard for the future. The longer I practice the greater percentage of clients I see getting taxed on their Social Security.
Calculating taxable Social Security isn’t straight forward. The amount a taxpayer is taxed on 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 some 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. There is also a “marriage penalty” aspect to this process. As mentioned above, a single taxpayer won’t pay tax on their Social Security until half their benefits and all the rest of their income is over $25,000. But a married couple only gets an extra $7000 in income before they start paying on their Social Security. A second taxpayer receiving Social Security could trigger taxability for a couple.
However, my biggest problem with taxing Social Security is there has never been an 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 may 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. Just don’t expect it to be an issue in the election or tax reform. It brings in too much money.