Taxes on Social Security Benefits -- Seriously?

Most people view their retirement as the reward for a lifetime of work, marking the transition from earning a living to living off money set aside for their non-working years. To cover living expenses during your retirement, you will likely depend on income from a mix of sources: Social Security retirement benefits, a retirement savings plan, personal savings, and, possibly, a pension plan. And while you may anticipate paying income taxes on money you withdraw from tax-deferred retirement accounts, you may not realize that some people are required to pay federal income taxes on their Social Security benefits as well.

What the Tax Rules Say

Not everyone has to pay income taxes on Social Security retirement benefits. Whether your benefits will be taxable depends on your "combined income" for the year. This term is defined as your adjusted gross income plus non-taxable interest income plus half of your Social Security benefits. Examples of the types of income that would be counted in figuring your combined income for this purpose include:

• Salary

• Pensions

• Net capital gains from selling investments in taxable accounts

• Tax-exempt interest from municipal bond investments

• Gambling, lottery winnings

• Tips

• Royalties

• Rental income

• Taxable withdrawals from individual retirement accounts (IRAs) and employer plans

If combined income is not above $25,000 for an individual, or $32,000 for a married couple filing jointly, Social Security is not taxed. But where combined income is higher than the threshold, a portion is subject to tax.

• Up to 50% of benefits are taxable if your combined income is between $25,000 and $34,000 (individual) or between $32,000 and $44,000 (married couple filing jointly).

• Up to 85% of benefits are taxable if your combined income is more than $34,000 (individual) or $44,000 (couple).

If you are married and file a separate return, you will probably have to pay taxes on your Social Security. Regardless of your tax filing status, however, no more than 85% of your Social Security benefits will be taxable, no matter how large your annual income is.

Your Choice

If your income is such that you will owe federal income taxes on your Social Security benefits, you can either file quarterly estimated tax payments with the IRS or ask Social Security to withhold income taxes from your benefit payments.

Your tax professional can answer any specific questions you may have about these rules and assist you with your tax planning.