Social security benefits are taxable for upper income taxpayers (§86). Up to 85% of social security retirement benefits may be includable in gross income based on a measure of income known as the modified adjusted gross income (MAGI), which is the taxpayer's adjusted gross income from all sources, including foreign earned income exclusion plus tax-exempt interest income minus social security payments. The purpose of using the MAGI is not to tax the additional income, but to assess the taxpayer's financial support.
The rationale for taxing just 85% of social security is that 15% is considered to be a return of what the taxpayer paid in. The other 85% is considered to have come from the employer's contribution plus the interest earned by the social security fund.
Taxable Social Security benefits may also include survivor and disability benefits. Supplemental Social Security (SSI), however, is not taxable. Each Social Security recipient receives Form SSA-1099, which shows the total amount of social security benefits paid. The net amount of social security benefits are listed in Box 5, which is the amount that may be subject to tax. Deducted Medicare premiums do not reduce the amount of social security that is subject to tax. The amount of social security benefits paid for a disability may also be reduced by the amount received as workers' compensation. Nonetheless, the full amount of benefits, both Social Security and workers' compensation, are taxable. Benefits paid on behalf of a child may be taxable to the child depending on the child's income, regardless of who actually receives the payments. Note, however, that the income received from Social Security cannot be used to calculate the earned income credit, or the foreign earned income exclusion, nor can it be used to determine allowable IRA contributions.
| Form SSA-1099 — Social Security Benefit Statement. |
|
| Source: IRS Publication 915 |
Tier 1 Railroad Retirement benefits that are designated as Social Security Equivalent Benefits, listed on Form RRB-1099, sent by the government to recipients, is taxed like Social Security. Other Tier 1 benefits and all Tier 2 benefits are treated as pension income under tax law.
| Form RRB-1099, Payments by the Railroad Retirement Board. |
 |
| Source: IRS Publication 915 |
A 30% withholding tax may be imposed on 85% of the Social Security benefits received by a nonresident alien, unless a relevant tax treaty specifies otherwise.
Social Security is taxed according to the following procedure:
Don't you just love doing taxes!
Many people who reach retirement age will have to continue working at least part-time work, since they will be unable to live only on their social security earnings. However, in computing the extra tax incurred by the extra work, the taxpayer has to consider not only the amount that she earns from her part-time job, but also that it may take her above the base amount, causing her to have to pay tax on her social security earnings. So, for instance, in Case #2 above, Penelope not only has to pay taxes on her working income, but she also has to pay additional tax on $3,000 of her Social Security income that would not be taxable but for the job (Case #1). In a sense, this is somewhat like double taxation. In addition, she will have to continue to pay Social Security and Medicare taxes on her working income, even though she may be collecting both.
Congress is always expressing worries that the social security fund will go bust, but here we have, in our convoluted tax code, a disincentive to work. After all, if senior citizens who are receiving Social Security and Medicare benefits continue to work, then they will continue to pay Social Security and Medicare taxes, thereby helping pay for the fund, even as they are collecting.
