Taxation Of Social Security Benefits

Social security benefits are taxable for upper income taxpayers (IRC §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 excluded foreign earned income + 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 a return of what the taxpayer paid in. The other 85% is considered to have come from the employer's contribution + the interest earned by the social security fund.

Taxable Social Security benefits may also include survivor and disability benefits. Supplemental Social Security, 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.

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.

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:

  1. For married taxpayers who file separate returns but lived together during the entire tax year, 85% of their social security benefits are taxable.
  2. Modified Adjusted Gross Income (MAGI) =
    • Adjusted Gross Income (AGI) except Social Security benefits
    • + any deductions or exclusions from income, or adjustments to income found on Schedule 1.
  3. Provisional Income = MAGI + ½ × (Social Security or Tier 1 Equivalent Railroad Retirement Benefits)
  4. Lower Base Amount:
    • $32,000 for married taxpayers filing a joint return.
    • $25,000 for all other taxpayers.
  5. Higher Base Amount:
    • $44,000 for married taxpayers filing a joint return.
    • $34,000 for all that all other taxpayers.
  6. If Provisional Income < Lower Base Amount, then none of the benefits are taxable.
  7. If Lower Base Amount < Provisional Income < Higher Base Amount, then the taxable amount of social security benefits is lesser of:
    • ½ of Social Security Benefits or
    • ½ × (Provisional IncomeLower Base Amount)
  8. If Provisional Income > Higher Base Amount, then the taxable amount of social security benefits is the lesser of:
    • .85 × Social Security Benefits, or
    • .85 × (Provisional IncomeHigher Base Amount) + lesser of:
      • amount of lower income procedure (#7), or
      • $4,500 ($6,000 for married filing jointly)

Examples of Calculating Taxable Social Security Benefits

Case #1

  1. Penelope, a single taxpayer, receives $22,000 in Social Security benefits as her only income. Since her income is less than the lower base amount, none of her income is taxable.

Case #2

  1. Same as Case #1, but Penelope works part-time, for which she is paid $20,000 annually. Her taxable Social Security income (SSI) is:
    • Provisional Income = ½ × $22,000 + $20,000 = $11,000 + $20,000 = $31,000
    • Since $25,000 < $31,000 (Provisional Income) < $34,000 then:
      • Taxable SSI = Lower of A or B:
        1. ½ of Social Security Benefits = $11,000
        2. ½ × (Provisional IncomeLower Base Amount) = .5 × ($31,000$25,000) = .5 × $6,000 = $3,000
      • Therefore, $3,000 of Penelope's Social Security benefits are taxable.

Case #3

  1. Same as Case #2, but Penelope inherited municipal bonds which pay her $12,000 in tax-free interest annually. Therefore, the amount of her Social Security benefits that is taxable is calculated thus:
    • Provisional Income = $20,000 + $12,000 + $11,000 = $43,000
    • Since $43,000 > $34,000, her taxable Social Security income is the lesser of A or B:
      1. .85 × Social Security Benefits = .85 × $22,000 = $18,700
      2. .85 × ($43,000$34,000) + lesser of a or b:
        1. Lesser of [$11,000 or .5 × ($43,000$25,000)] = Lesser of $11,000 or $9,000 = $9,000
          • (Here, we are applying the procedure in Case #2, but with the added $12,000 in tax-free interest. Note the lower base amount — not the higher base amount — is still subtracted in this procedure.)
        2. $4,500
      3. = .85 × $9,000 + $4,500 = $7,650 + $4,500= $12,150
      4. Since $12,150 < $18,700, Penelope's taxable Social Security income = $12,150.

Don't you just love doing taxes!

Beware of the Results of These Convoluted Calculations

Many people who reach retirement age must 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, you have to consider not only the amount that you earn from any part-time job, but also that your income may exceed the base amount, creating an additional tax liability on your social security earnings. So, for instance, in Case #2 above, Penelope not only must pay taxes on her working income, but she also must 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 must continue to pay Social Security and Medicare taxes on her working income, even though she is receiving benefits from both. Here is a table that illustrates this idea better, for a single taxpayer, with the MAGI equal income earned from work:

MAGI Social
SS Taxable %
$0 $50,000 $25,000 0%
$25,000 $25,000 $37,500 30%
$30,000 $20,000 $40,000 48%
$40,000 $10,000 $45,000 85%

Notice that a taxpayer not only has to pay the regular marginal tax AND employment taxes on the earned income, but she must also include a greater percentage of her social security in her income. Note the difference between the 1st row and the last. A taxpayer receiving $50,000 in social security benefits does not have to pay any tax on it. But if the taxpayer receives only $10,000 in social security, but supplements it with earned income of $40,000, then, not only does the taxpayer have to pay all of the usual taxes on his earned income, but he also has to include 85% of his social security in his taxable income. What a hefty difference, even though both taxpayers receive $50,000 of income. I would also like to note that since Social Security is also not taxed by most states and localities while earned income is usually taxed by both entities, the taxpayer with earned income is truly being penalized for working!

Congress continually worries about the social security fund going bust, but here we have, in our convoluted tax code, a disincentive to work. After all, if senior citizens 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.