At one time, all Social Security retirement benefits were tax free. However, the tax rules are not quite as simple today; instead, benefit recipients fall into one of three categories:
- For most recipients, benefits remain tax free.
- For some recipients, up to 50 percent of benefits are taxed.
- For the most affluent retirees, up to 85 percent of Social Security retirement benefits are considered taxable income.
Whether benefits will be taxable depends on a person’s income tax filing status—single or married filing jointly—and the amount of his or her modified adjusted gross income (AGI). Individuals whose total income (from practically all sources, including investment income and pensions) exceeds certain threshold limits may be surprised to discover that part of their Social Security retirement benefits will be taxed.
Determining the Amount of Taxable Benefits
The amount of Social Security benefits that are taxable depends on the extent to which a person’s modified AGI, plus half of his or her Social Security benefits, exceeds specified threshold levels:
- Benefits will not be taxed if a single person’s modified AGI plus one-half of his or her Social Security benefits is less than $25,000 (in the case of married couples filing jointly, the threshold level is $32,000).
- Up to 50 percent of Social Security benefits are taxed if income is between $25,000 and $34,000 for single filers and $32,000 and $44,000 for joint filers.
- Up to 85 percent of Social Security retirement benefits are taxed if income is more than $34,000 (if single) or $44,000 (if married filing jointly).
- Individuals who are married but file separate returns are generally taxed on 85 percent of their Social Security benefits.
Unlike other numerical figures in the Tax Code, these threshold levels are not indexed for inflation, which means that more and more retirees will fall into the group whose Social Security retirement benefits are taxed. Calculating whether a client’s benefits will be taxable one day requires you to predict what his or her future earnings will be. This can be critical to retirement planning, because tax-free benefits obviously go much further than those that are subject to tax.
Modified Adjusted Gross Income
For purposes of this test, modified adjusted gross income includes the following:
- wages
- interest and dividend income
- taxable pensions
- other investment income
- wages from part-time or full-time work
- tax-exempt interest income
- excludable interest income from U.S. savings bonds
- excludable foreign-earned income
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About Stu: With more than 29 years of experience as a tax professional, Stu Steinberg brings a broad depth of knowledge to his work with his clients. Stu founded Erock Tax to help provide tax and financial planning strategies to individuals, families and small businesses and is passionate about empowering his clients through education about their money health. Stu is highly energetic and brings a sense of optimism, creative problem-solving and a deep level of commitment to every Erock client.