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.
If you receive Social Security or Social Security Disability Insurance (SSDI) income, you will also receive a Form SSA-1099 from the government. This form tells you the total amount of your benefits but does not tell you if any of your benefits are taxable, or at what percentage.
You can IRS Free File to e-file your return (if you make no more than $64,000), and the software will figure the taxable component of your benefits for you. However, you can get a reasonable estimate by combining half of your Social Security benefits with all other income (including tax-exempt interest) and comparing it to the base amounts that are excluded from tax. Anything over the base amount may be taxable.
The base amounts are $32,000 for married filing jointly and $25,000 for all other filing statuses, with one exception. If your status is married filing separately and you lived with your spouse at any time during the tax year, all of your SSA/SSDI benefits are taxable.
Between Form SSA-1099 and Notice 703 (a worksheet that is included with your SSA-1099), you should have all the information you need.
Notice 703 guides you through summing up three income sources:
- SSA/SSDI Benefit Components – Box 5 in Form SSA-1099 contains your net SSA/SSDI benefits for tax purposes. It is the total in Box 3 (all benefits paid minus deductions, along with explanations) minus the total in Box 4 (any payments or other money going from you back to the Social Security Administration).
Sum up the totals in Box 5 for all the SSA-1099s that you receive, including your spouse's if he or she also receives benefits and you are filing jointly. One-half of that total serves as your income for these calculations.
- Taxable Income – Other sources of income as listed on your Form 1040 covering taxable pensions, wages, dividends, and interest. This is the total of most of the income boxes in lines 7-21 of your Form 1040 with the exception of non-taxable portions of pensions and annuities and tax-exempt interest (lines 8b, 15a, and 16a, respectively).
- Tax-Exempt Interest and Exclusions – This covers the tax-exempt interest in Form 1040, line 8b (such as interest from U.S. Savings Bonds) and various exclusions, like foreign-earned income. Details may be found in IRS Publication 915, "Social Security and Equivalent Railroad Retirement Benefits".
The total of these three constitutes Line E in Notice 703. From this total, subtract the "above-the-line" deductions from your 1040 form (lines 23-32 plus write-in adjustments). In essence, you are calculating an adjusted gross income (AGI) based on your SSA/SSDI benefits. None of your benefits are taxable if the result is smaller than the base value for your filing status.
If the result is higher, some of the amount over your base status will be taxable. You need to perform another calculation to determine whether the maximum of 85% of your benefits or a lesser amount will be taxed. 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.
It sounds convoluted – and to a certain extent, it is – but Publication 915 provides sample worksheets filled out showing different scenarios regarding deductions and other sources of income to help you find the calculation that most closely matches your situation. It will direct you to worksheets in other publications for special situations such as having combined IRA's and a work-related retirement plan.
This process allows you to minimize or eliminate tax on your Social Security benefits, so be sure to take advantage. Do not let some calculations, worksheets, and tax jargon scare you away from potential tax savings.
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. If you find the process too confusing, you can use the Interactive Tax Assistant tool at IRS.gov or consult with a qualified tax professional to help you determine your taxable benefits.
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