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Could it be your Social Security income will be taxed?

Ike Trotter

Many new retirees today assume that Social Security income (SSI) is tax-free. Unfortunately, that is not always the case these days. This is because the door to taxation was opened in 1983 when Congress passed a law in which some might have to pay . . . depending on the amount of income earned.

How much of your SSI is potentially taxable? As much as 85% under certain conditions. There are four primary factors that determine how much of your SSI will be taxed:

1: The total amount of income that you earn

2: Where this income comes from

3: Your taxpayer filing status

4: Your “provisional” income which is an income calculation you can figure out by using Worksheet 34-1 in IRS Publication 915 or the Social Security Benefits

Worksheet in the instruction booklets for IRS Form 1040 and Form 1040A

This provisional income is determined, in simple terms, by calculating your adjusted gross income minus one-half of your Social Security benefits. Interestingly enough, tax-free interest from investments such as muni bonds can also be considered provisional income. Take note, however, that if your only source of income is Social Security or equivalent retirement railroad benefits, it is unlikely that your SSI will be taxed and you may not even need to file a federal return.

Here are the current limits on how much income you can earn before having your SSI taxed:

>> Single person: up to 50 percent of your SSI can be taxed if you provisional income is greater than $25,000, and up to 85% of your SSI can be taxed if your provisional income exceeds $34,000.

>> Married / Head of Household: up to 50% of your SSI can be taxed if your if your provisional income is greater than $32,000, and up to 85 percent of your SSI can be taxed if your provisional income exceeds $44,000.

What can be done to reduce or avoid the tax? If you are close to hitting either the 50 percent or 85 percent tax levels, you may want to think twice about financial opportunities that could take your provisional income over the threshold. For example; what happens if you realize a sizable chunk of profit from selling a stock or converting a traditional IRA to a Roth IRA? Here are a few options some have found useful in that regard:

>> Delay some investment income, rental income or pension income until the following tax year

>> Shift assets from accounts or investments producing reportable income (such as CDs) into tax deferred alternatives

>> Work Less (easier said than done!?!)

>> Increase your pre-tax contributions to an IRA, 401(k) or 403(b) plan

There are five months left before the end of taxable year 2012. And, as I mentioned at the top of this article, many new SSI recipients are quite surprised when they find out they owe taxes on income most assume to be “untaxed”. That makes it even more important that you get started now to manage the “potential” tax load generated from your Social Security check. Believe me, taking the time to reduce its impact is time well spent.



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About Ike Trotter

One comment

  1. Robert Stewart

    You shouldn’t use the term SSI since SSI is different from Social Security Income. SSI is used by the government as Suppelmental Security Income, a separate plan from Social Security Income and one that ISN’T subject to taxation.

    Not sure why you’d encourage people to work less. In the end, that only hurts them in the long run.

    Also, the rules for taxation apply to people receiving SSDI (Social Security Disability, occasionally abbrev. SSD instead of SSDI). I received a back pay lump sum in 2010 and combined with my wife’s income, I was hit with owing taxes on it.

    A person/couple needs to weigh the benefit of paying the taxes vs. doing things to reduce the tax liability. And that is where most tax advisers or experts mess up the worst. Yes, you can do all sorts of things to reduce your tax liability, but most of them aren’t financially worth it.

    For example, you owe 45% taxes (fed, state, local) on $100,000, but you could spend $100,000 on stuff that reduces your taxes. Most tax experts would tell you to spend the $100K because you saved $45K in taxes even though you paid out $55K for a net loss of $10K. If you had not spent the $100K, you would owe $45K in taxes and have $55K left over for a net gain of $10K.

    Some tax experts make it sound like you’re getting back money that you didn’t pay in. It really doesn’t matter if that’s true because you are still out $55K (or $100K using that logic). I’d rather have $55K in my pocket than $45K.

    Another example, you owe 33% taxes on $10,000. If you spent the $10K, you’d get back $3.3K, but be out $6.7K. If you paid the taxes, you’d pay the $3.3, but have $6.7K, over twice what you would

    Don’t ever spend money just to reduce taxes unless your total tax liability is 51% or more (federal, state, local, etc.). Currently, there aren’t any places in the US where your total tax liability exceeds 50%. Parts of NY and CA are doing their best to break that barrier.

    This is also a great time of year to estimate your taxes. FYI, with the exception of refundable credits (EIC, etc.), the refund you get every year is from money you loaned the govt. interest free, You could stick that money in a Christmas Club (vacation account, whatever) and at least earn some interest on that money. There’s no sense in giving the govt. that money interest free. Take the money from your next refund, stick it in a CD or other account that comes due before April 15 of next year. Then, if possible, determine your taxable income for the year. Reduce your taxes so you will owe nothing and get nothing back, or close to it. If you don’t think you can save the money, guess what you can. If nothing the Christmas Club/vacation account/CD makes it where you can’t spend it.

    Makes allowances for raises, bonuses, etc. and review your projected income quarterly. Make adjustments as needed, and if necessary, make estimated payments.

    Also, if you win a decent sized lottery, make estimated payments because they don’t withhold enough taxes. I checked Mega Millions and PowerBall. The amount they withhold from your winnings is a lot less than your probable income taxes (state, fed., local). You could easily owe as much in taxes as they withheld. Even if you only take the estimated payments and put them in a CD/whatever, don’t spend it.

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