Social Security is generally considered a tax-free benefit, but that is not always the case. Depending on the amount of alternate income that you have in retirement and your filing status, you could owe taxes on up to 85% of your Social Security benefits.
The threshold for taxable Social Security payments starts with your "combined income" as defined by the Social Security tax laws. Combined income is your adjusted gross income from the appropriate tax form (line 37 on the standard 1040 form) plus any non-taxable interest and one-half of your Social Security benefits.
Non-taxable interest includes such things as interest on municipal bonds that would not show up anywhere else in the income element of the 1040 form. Your Social Security Benefits for the tax year will be summed up in your benefit statement Form SSA-1099 or the Railroad Retirement Equivalent (RRB-1099).
IRS Publication 915, "Social Security and Equivalent Railroad Retirement Benefits" contains further details on taxable portions of benefits along with several worksheets showing how to calculate the amount of your Social Security taxes.
Sample worksheets are filled out showing different scenarios regarding deductions and other sources of income to help you find the calculation that most closely matches your situation. Publication 915 will direct you to worksheets in other publications for special situations such as having combined IRA's and a work-related retirement plan.
When filing as an individual, your Social Security benefits are not taxable as long as your combined income is $25,000 or less. With a combined income between $25,000 and $34,000, you could have tax obligations on up to 50% of your benefits. At incomes above $34,000, up to 85% of your benefits could be taxable.
When filing a joint return, you and your spouse's combined income must be $32,000 or below to avoid taxes. If your income is between $32,000 and $44,000, you may be subject to taxes on up to 50% of your benefits. Above $44,000, up to 85% of your benefits may be taxable.
If you are married filing separately, it is likely that you will pay taxes on your benefits as long as you lived with your spouse at any point during the tax year. In the case when you are married filing separately and did not live with your spouse at any point during the tax year, your taxable status will effectively be the same as individual filers.
If you determine that you do have to pay taxes on your benefits, you can have federal taxes withheld from your benefit package or make periodic estimated payments of your tax to the IRS. Any estimated tax payments are made quarterly, just like self-employment taxes.
Note: At the state level, Social Security benefits often enjoy tax-free status. You will need to consult the laws in your state to verify if you owe any state tax obligations on your Social Security benefits.
To avoid paying taxes pre-emptively on your Social Security benefits, run a series of calculations to find out the maximum income outside of Social Security that you can bring in without triggering the taxes. Use the spreadsheets available in Publication 915 as a reference and work backwards from the benchmark combined income value that matches your filing status. You may not be able to avoid taxes completely, and the amount of income that you bring in may be worth the extra tax payments, but at least you can do a cost-benefit analysis on your options.
Need more help? You can use the Interactive Tax Assistant tool at IRS.gov, and IRS Free File is available online for those earning $62,000 or less. These programs can help you avoid mistakes that can cost you money. If you need help determining your taxable benefit status, do not hesitate to ask.