For some new Social Security recipients, it comes as a shock when they see their benefits taxed by the federal government. Will this be the same for you? Maybe, maybe not.
Whether you have to pay taxes on your benefits depends on your other income. In situations where your income is high, you can expect the feds to tax anywhere between 50-85% of your monthly payment. Don't worry, though. This doesn't mean you'll lose that much of your benefits, just that that percentage would be subject to taxation.
Understanding your income
Understanding how much you can expect to pay in tax for your Social Security benefit requires assessing how much other income you have. This could include certain items that are usually tax-free, like tax-exempt interest. Combine that income with your spouse's income on your joint tax return.
Next, half of your and your spouse's benefits are added to the sum. The final figure you calculate should be your total combined income plus half of the social security payments received. This total should have the following rules applied to it:
- Your benefits remain untaxed when your income and half benefit amount don't exceed $32,000 for married couples or $25,000 for single taxpayers.
- When your income and half benefit total exceeds the $32,000 threshold but is less than $44,000, half of the excess amount over $32,000 gets taxed, or half your benefit amount, whichever is less.
An illustrative example
Let's say you and your spouse have $20,000 in taxable dividends, $2,400 of tax-exempt interest, and combined Social Security benefits of $21,000. So, your income plus half your benefits is $32,900 ($20,000 + $2,400 +½ of $21,000). You must include $450 of the benefits in gross income (½ ($32,900 − $32,000)). If your combined Social Security benefits were $5,000, and your income plus half your benefits were $40,000, you would include $2,500 of the benefits in income: ½ ($40,000 − $32,000) equals $4,000, but half the $5,000 of benefits ($2,500) is lower, and the lower figure is used.
Important Note: If you’re currently paying taxes on your Social Security benefits since your income is under the threshold, or if you're only liable for 50% taxes on your benefits, you risk triple taxation if your income increases. This means an increased tax liability on your Social Security (or an increase), paying taxes on your additional income, and potentially ending up in a higher marginal tax bracket.
This can sometimes occur when taking a large IRA distribution or having significant capital gains. Planning ahead to avoid these negative tax implications is always wise. You may have ways to spread out this new income over several years or liquidate non-IRA accounts, including items like a stock that only makes small gains or those with gains or a capital loss on shares to offset.
Consider filing a Form W-4V to have tax withheld from your payments if you know your benefits will get taxed. If not, then you can always make estimated quarterly tax payments. You should remember that while most states don't tax your Social Security payments, there are a dozen that do. Contact us for assistance or more information.
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