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Taxes on Social Security Benefits Explained

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Is Social Security taxed after 70? It might be. This is a question many people ask. Unfortunately, there isn’t a universal answer, because everybody’s situation is different. It doesn’t depend on your age, but on your income.

We all pay a lot into the Social Security System. The total Social Security tax is 12.4%. Half of that tax is paid by the employee, while the other half is picked up by the employer.

This means that the average American pays around $3,045 a year in taxes to support the Social Security program. In other words, if you work 40 years, then you will probably pay over $120,000 into Social Security. Of course, the tax rate has changed over time, but this is a pretty good estimate.

Many people don’t realize that they need to pay taxes on their Social Security earnings. Isn’t the money already taxed? Didn’t you already pay so much into that the system that you deserve to get the benefits tax free? Unfortunately, that is not the case.

Many people are forced to pay taxes on their Social Security earnings. The Social Security Administration issues a SSA-1099 form to you every year. This form tells you exactly how much money you received in Social Security benefits. They also send a copy to the IRS as well. If your Adjusted Gross Income (AGI) is over a certain threshold, then you will be obligated to pay taxes on your Social Security benefits. If you don’t report your income, then you will receive a Notice of Underpayment from the IRS. You will have to pay interest on unpaid tax debt (which will have already started accumulating retroactively before the notice was mailed). You may also have to pay penalties as well, depending on whether the IRS felt you were negligent about reporting taxes from Social Security benefits.

Who Needs to Pay Taxes on Social Security Benefits?

The thresholds for paying taxes on Social Security benefits depend on whether you are single, married and filing jointly, or married and filing independently. Couples that usually file their taxes separately may want to start changing their filing status after they begin receiving Social Security benefits because they get the worst end of the stick when it comes to being taxed on their Social Security benefits.

You don’t have to pay taxes on all of your Social Security income. The share that you will need to pay will either be 0%, 50%, or 85%. It varies according to your filing status, your AGI and whether you and your spouse were separated at any point during the tax year in question.

You will be required to pay taxes on benefits if you are single and have an AGI over $25,000. Married people filing jointly will also need to pay taxes on their benefits if they have an AGI over $32,000. Married people that file their tax returns separately must always pay taxes on some of their Social Security benefits, provided they lived together for the entire year.

If you and your spouse were not living together for part of the tax year, then you will both be held to the same rules as single people. This rule applies if you got married after January 1 of the tax year, were separated for part of the year, or received a divorce. This rule applies even if you still have power of attorney over your spouse.

The tax requirements for Social Security benefits are outlined below:

  • You will not need to pay any taxes if you are single and have an AGI less than $25,000 or are married and filing jointly with a household AGI less than $32,000.
  • You will need to pay taxes on 50% of your benefits if you are single with an AGI between $25,000 and $34,000 or are married and filing jointly with an AGI between $32,000 and $44,000.
  • You will need to pay taxes on 85% of your benefits if you are single with an AGI over $34,000 or married and filing jointly with an AGI over $44,000.

The portion of your benefits that are taxable will be subjected to the same tax bracket as the rest of your income. Here is an example to help illustrate this situation:

You are a single taxpayer with an Adjusted Gross Income of $27,000, which includes $7,000 in Social Security benefits. Under the new tax law, you will be subjected to a 12% tax bracket. Since you make less than $34,000 a year, only 50% of your benefits are taxable. This means that you must pay a 12% tax on $3,500 of your Social Security benefits. Your total tax on Social Security benefits is $420.

You can look at the worksheet under IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits for more information. It will help you determine the amount of taxes that you must pay on your Social Security earnings.

Is Any Income Excluded?

Some of your taxable income can be excluded for the purpose of determining whether some of your Social Security benefits are taxable. The income that doesn’t count towards the allowance is listed under IRS Publication 915. Here are some of the types of income that will not count towards your Social Security benefit allowance:

  • Qualified U.S. savings bonds (as shown on Form 8815 of the IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits worksheet);
  • Adoption benefits (as shown on Form 8839 EZ of the IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits worksheet);
  • Qualified foreign earned income or housing income (as shown on Form 2555 or Form 2555-EZ of the IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits worksheet);
  • Income earned in American Samoa (as shown in Form 4563 EZ of the IRS Publication 915, Social Security and Equivalent Railroad Retirement Benefits worksheet) or Puerto Rico by bona fide residents.

If your AGI appears to exceed the allowed thresholds, then you will want to review your income to see if you meet any of these qualifications. Keep in mind that the income listed above may still be taxable. It simply doesn’t count towards the limit for determining whether or not you need to pay taxes on Social Security benefits. You still need to report it on your 1040.

How Are Lump Sum Payments from Previous Years Taxed?

Figuring out whether or not you need to pay taxes on Social Security benefits you earned is complicated enough. It becomes even more complicated when you receive a lump sum payment for benefits that should have been received in previous years. A number of factors come into play:

  • The AGI of all previous years that you are receiving benefits for
  • The tax rates of the years in question (keep in mind that the tax brackets were changed in 2018, which complicates the calculations further)
  • Whether you already paid taxes on benefits that you received before receiving the lump sum

You will need to use IRS Publication 915, Social Security, and Equivalent Railroad Retirement Benefits worksheet to determine the taxes that you need to pay (if any on your benefits). These calculations can get very messy and it can be difficult to determine whether you need to pay taxes on the benefits at all, so you may want to consider working with a professional if you receive a lump sum payment of Social Security benefits.

How to Reduce or Eliminate Social Security Taxes

If your AGI is over the limit, then you may want to look for ways to reduce it. You can claim deductions or rebalance your retirement account to limit your taxable income. By reducing your AGI, you may not have to pay taxes on some or all of your Social Security earnings. Here are some tips that you should consider trying:

  • Take advantage of tax-free withdrawals from IRA before getting Social Security benefits. If you withdraw this money before you start receiving benefits, it can be put in a standard checking account for future use. You can use this money to pay for your living expenses, so you don’t need to declare capital gains taxes on any shares that you sold.
  • Make charitable donations. You can donate part of your IRA to charity if you want.
  • Switch your portfolio to be more focused on equities, especially if they have few dividends. Capital gains will count towards your AGI, but you only pay them after selling shares. It is easier to control your AGI by selling stocks when needed and budgeting your money throughout the year. You can’t control your interest income the same way and it is easier to go over the limit with interest-earning investment vehicles.
  • If you have self-employment income and are just on the line of needing to pay taxes on your benefits near the end of the year, considering asking your clients if they can pay you after January 1 and declare your earnings then. This may keep you from crossing the limit and needing to pay taxes on 50% of your Social Security earnings.
  • Considering rebalancing your portfolio to include more municipal bonds. You can get tax-free income from municipal bonds. While the interest isn’t as high as most other investments, you will find that the ROI can be much higher if it spares you from needing to pay a 12% income tax on 50% of your Social Security benefits.
  • See if any nursing care services can be deductible if your spouse is in a senior living facility.

Take advantage of any deductions that you can to reduce your earnings below the allowable limit.

Dealing with Taxes on Overpayments

You may receive overpayments on your Social Security earnings. This is common for a lot of reasons. Unfortunately, even if the overpayment was the Social Security Administration’s fault (which happens for a number of reasons), you still need to pay taxes on the benefits. The tax rules for overpayments on Social Security benefits are the same as any other Social Security benefits that you have been paid.

Here are the general rules that you will need to be aware of.

Repaying Overpaid Benefits in the Same Year

If you repay the overpayment in the year that is was made, you simply deduct it from the reported benefits. This can reduce your taxable benefits and even keep you from owing taxes on any benefits.

Repaying Overpaid Benefits in a Subsequent Year

If you repay overpayments at a later date, you will need to claim the repayment on the year it was made. The process depends on the amount of the overpayment:

  • You paid less than $3,000 in benefits. You will need to itemize your taxes and claim the overpayment as a deduction. The deduction is applied to the tax return of the year that the benefits were paid. You don’t need to file a new tax return for that year.
  • You paid over $3,000 in benefits. You can either claim it as a deduction or a tax credit. The credit is applied to the tax return of the year that the benefits were paid. You don’t need to file a new tax return for that year.

If you have a large overpayment, you will want to try paying as much as possible, so you can qualify for the tax credit. This means that you can still have the option to claim the standard deduction if you want and don’t need to do the extra work of itemizing your taxes. The value of the tax credit should also be much higher than the value of a deduction.

Conclusion

Understanding the taxes that you may need to pay for Social Security benefits is very confusing. The portion of your benefits that are taxed varies according to a number of factors and you need to understand all the nuances associated with determining your AGI for these purposes. You also need to deal with other confusing issues, such as getting a huge lump sum benefit from previous years or needing to repay benefits that have been overpaid.

Fortunately, it is easier to understand the legal framework if you have done your due diligence. If you are still struggling to figure out whether you owe taxes on your Social Security benefits, you can always talk to an expert.

Please don’t hesitate to contact us if you need help understanding the taxes on your Social Security benefits. We will be happy to assist!