Q. I begin taking my Social Security next month and want to know how much, if any, of it will be subject to tax. Is it just earned income that has an impact on benefits? Also, if my benefits will be subject to tax, at what rate will it be taxed?
A. The amount of your Social Security benefit subject to tax depends on your marital status and “combined income.” The rate at which your benefits are taxed will depend upon your income tax bracket. Your “combined income” for this purpose is your adjusted gross income (AGI) plus any non-taxable interest plus one-half of your Social Security benefits.
If you file your taxes as single, head of household, qualifying widow or widower with a dependent child of married filing single and have not lived with your spouse for the entire year, the significant combined income amounts are $25,000 and $34,000. If you file jointly, the amounts are $32,000 and $44,000. If your combined income is at or below the lower amounts stated above, none of your benefits will be subject to income tax. If your combined income is between the lower and the higher amounts stated above, up to 50 percent of your benefits will be subject to income tax. If combined income is greater than the higher amounts stated above, up to 85 percent of your benefits will be subject to income tax.
Earned income may impact your benefits in three ways. The more earned income you have the higher your AGI. This may make your “combined income” surpass the lower income thresholds and subject up to 50 or 85 percent of your benefits to tax. Earnings may also bump you up into a higher income tax bracket. If you are below normal or full retirement age, benefits will be reduced if your earnings exceed a certain level. Once you reach FRA, earnings will not reduce your benefits; there is no limit on what you can earn. If you will not reach FRA in 2014, you can earn $15,480 without impacting your benefits. For every $2 of earnings above $15,480, $1 of Social Security benefits will be withheld. If you will reach FRA in 2014, earnings up to $41,400 will not impact benefits. For every $3 of earnings above $41,400, $1 of benefits will be withheld. Earnings in or after the month you reach FRA do not impact your benefits.
The rate at which your benefits will be taxed depends on your federal income tax bracket and whether your state taxes Social Security benefits (currently, benefits are exempt from state tax in North Carolina). Currently, there are seven tax brackets: 10, 15, 25, 28, 33, 35 and 39.6 percent. The standard deduction for a single filer is $6,200 (an additional $1,550 for those age 65 and above or blind) and for those married filing jointly it is $12,400 (an additional amount of $1,200 for those age 65 and above or blind). Personal exemptions are $3,950 for tax year 2014.
Simplistic example: If a married couple over 65 have no dependents (personal exemption of $7,900), take the standard deduction ($14,800 because they’re over 65) and receive $40,000 in Social Security benefits, they can have other income of up to $12,000 and none of their benefits will be subject to tax for two reasons: 1) Their “combined income” (non-SS income + half of their SS benefit) is $32,000 and 2) after taking the standard deduction and exemptions their taxable income is zero. If other income is $19,133, they will have taxable SS benefits of $3,567 (non-SS income + half of SS benefits = $39,133, which is $7,133 over the lower income threshold but still below the higher threshold. Fifty percent of $7,133 = $3,567, which is the amount of SS benefit subject to tax. Their AGI is now $22,700. They have taxable SS benefits, but after taking the standard deduction and personal exemptions, they still owe no tax. Non-SS income over $19,133 will cause them to be subject to income tax. Non-SS income over $24,000 will make their “combined income” higher than the upper threshold of $44,000, and therefore, 85 percent of their SS benefits will be subject to income tax.
IRS publication 915 has worksheets and very good explanations on this subject.
Holly Nicholson is a certified financial planner in Raleigh. She cannot answer every question. Reach her at askholly.com or P.O. Box 97128, Raleigh, NC 27624