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This Social Security Tax Solution Is Long Overdue
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This Social Security Tax Solution Is Long Overdue

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This Social Security Tax Solution Is Long Overdue

Social Security provides an essential financial backstop for tens of millions of American families. It therefore comes as a huge shock to many people that the Social Security benefits they receive from the federal government can sometimes be subject to income tax.

Americans pay Social Security payroll taxes throughout their jobs. In exchange, they expect that they'll receive monthly retirement benefits after they quit working. Having paid into the system through taxes, it's surprising to have to pay taxes on the benefits Social Security pays out. But millions of people do -- and that number has been on the rise for years.

Fortunately, there's a solution. First, though, let's look at the full scope of the problem.

Image source: Getty Images.

Yes, Social Security benefits are taxable -- sometimes

To be clear, not everyone has to pay income taxes on their Social Security benefits. The key question is how much money you get in income, both from Social Security and from other sources.

The IRS looks at certain threshold amounts to determine whether you'll have to add some of your Social Security income onto your tax return. The amounts refer to a figure called combined income. To figure your combined income, you need to take your total income from sources other than Social Security, which includes things like wages and salaries, investment interest and dividends, capital gains, and other items you generally have to include as income on your tax return. Then, add in one-half of your Social Security benefits.

The exact calculation of how much of your benefits you have to include as taxable income gets complicated. However, in general, the following rules apply:

  • If you're single and make $25,000 or more in combined income, up to 50% of your benefits can be subject to tax. Make more than $34,000, and you might have to add in up to 85% of your benefits as taxable income.
  • The corresponding numbers for joint filers are $32,000 for the 50% level, and $44,000 for the 85% level.

Keep in mind: You won't pay 50% or 85% in taxes on your benefits. You'll just have to include that amount as taxable income. From there, your normal tax bracket will apply to figure how much tax you owe.

The simple solution

When this rule took effect in the early 1980s, it wasn't such a big deal. That's because back then, $25,000 to $32,000 in combined income was a lot of money. The tax therefore affected only a small number of people.

However, those threshold amounts were not indexed for inflation. Therefore, more and more people have had to pay taxes on their benefits. Now, it doesn't take an upper-class lifestyle to have some of your benefits taxed.

If lawmakers had indexed those amounts to inflation back in the early 1980s, then the threshold figures would be much higher by now. Some recent estimates put the potential indexed figures for the lower threshold around $65,000 for single filers and $83,000 for joint filers.

Why it probably won't happen

Unfortunately, Social Security is in poor financial condition, and it needs all the money it can get. Even though income taxes on benefits aren't a huge source of revenue for the program, they still make a meaningful contribution. Doing without them would hasten the depletion of the Social Security trust funds and potentially threaten benefit payments sooner.

Therefore, you should do your tax planning under the assumption that the current income tax provisions will govern Social Security benefits. Although you can hope for a change, it's better to expect the worst -- that you might still face having to give back some of your hard-earned Social Security.

The $16,728 Social Security bonus most retirees completely overlook

If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $16,728 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after. Simply click here to discover how to learn more about these strategies.

The Motley Fool has a disclosure policy.

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