Pay Tax on Social Security Benefits?
If you’re nearing retirement, you may wonder: Will I have to pay taxes on my Social Security benefits? And if so, how much will you have to pay?
It depends on your other income. If you owe taxes, you may have to pay tax on 50% to 85% of your benefits. (This doesn’t mean you pay 85% of your benefits back to the government in taxes. It merely means that you’d include 85% of them in your income subject to your regular tax rates.)
Crunch the numbers
To determine how much of your benefits are taxed, start by calculating your other income. This includes items normally excluded from taxes—like tax-exempt interest. Add to that the income of your spouse, if you file joint tax returns. To this, add half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your total income plus half of your benefits. Now apply the following rules:
- If your income plus half your benefits isn’t above $32,000 ($25,000 for single taxpayers), none of your benefits are taxed.
- If your income plus half your benefits exceeds $32,000 but isn’t more than $44,000, you will be taxed on one half of the excess over $32,000, or one half of the benefits, whichever is lower.
Here’s an example
For 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 +1/2 of $21,000). You must include $450 of the benefits in gross income (1/2 ($32,900 − $32,000)). For example, if your Social Security benefits total $5,000 and your income plus half your benefits equals $40,000, you would include $2,500 of the benefits in your taxable income. You calculate this by taking half of the amount over the $32,000 threshold: ½ × ($40,000 − $32,000) = $4,000. But since ½ of your benefits is only $2,500, you use the lower amount.
Important:
If you aren’t paying tax on your Social Security benefits now because your income is below the floor, or you’re paying tax on only 50% of those benefits, an unplanned increase in your income can have a triple tax cost. You’ll pay tax on the additional income, pay tax on more of your Social Security benefits (because the higher your income, the more of your benefits are taxed), and you may move into a higher marginal tax bracket.
For example, this situation might arise if you receive a large distribution from an IRA during the year or you have large capital gains. Careful planning might be able to avoid this negative tax result. You might spread the additional income over multiple years or choose to liquidate assets other than an IRA—such as stocks with small gains or gains that you can offset with capital losses on other shares.
If you know your Social Security benefits will be taxed, you can voluntarily arrange to have the tax withheld from the payments by filing a Form W-4V. Otherwise, you may have to make estimated tax payments. Contact us for assistance or more information.
Beach Fleischman 2201 E. Camelback Rd. Phoenix, AZ 85016 | 602.265.7011 | http://beachfleischman.com | twitter: @BeachFleischman
Reprinted with permission from BeachFleischman, CPA Firm. Original article HERE.