Congress Double-Dips On Social Security Tax!

Sometimes I have to be the bearer of bad news to my clients when they ask if they have to pay any taxes on their social security benefits.  Didn't I already pay taxes on that money? Well, yes, but for now lets just establish the ground rules.... Don't shoot the messenger.

Lets first start with the basics.  Throughout your working life when you received a paycheck (hopefully a big fat one) you would also see the federal withholding tax being charged against the entire amount.  I realize there are some deductions, such as retirement contributions, which may reduce the amount being taxed but for the most part you are paying tax on your gross earnings.  Then our friends (AKA, IRS)  also take some money out for social security and Medicare so the government can take care of us when we are old and senile (sometimes my wife thinks I'm already there). This means the social security fee that goes to the government has already been taxed. Let's call this tax number 1.

Now, here you are in much later years, with lots of grey hairs in your head, grandkids running amok and a wobble in your step.  It is now time to start receiving your social security.  You receive that whopping social security check every month and you also continue with some part time ventures to help pay for toys for the grandkids.  But at the end of the year, when your CPA calculates your taxes he also gives you the news that some of your social security was taxed again.  Tax number 2. Remember.... Don't shoot the....

Continuing the discussion, let me explain that the taxes placed on social security are certainly not straightforward because that would simply be too easy for Congress.  So, here are some of the rules to determine how much of your benefits are taxable:

• Start with all taxable income you derived from working, plus any taxable retirement money you received (e.g. pensions, IRA, etc) plus any interest earned less any adjustments allowed on page 1 of the 1040 tax form.  And then you add 1/2 of any social security benefits you received for the year.  This is called your "Modified Adjusted Gross Income". I know, its a downright fancy term which you can use at the next party. Excuse me, but what is your "modified adjusted gross income".  Lets call this the MAGI.
• If this MAGI is below $25,000 (for singles) or $32,000 (for us married folk) then none of your benefits are taxed.  
• If this MAGI is between $25,000 - $34,000 (for singles) or $32,000 - $44,000 (for the blissfully married) then 50% of this portion of benefits are taxed.
• If you have MAGI greater than $34,000 (table for one please) or $44,000 (the hitched people) then 85% of this portion of benefits are taxed.

It should be no surprise to anyone that there are lots of exceptions and special circumstances which is why the IRS publishes a 30 page document (called Pub 915) which is guaranteed to put you to sleep.  In any case, if you only receive social security benefits then you are good to go but for many people who require an extra income during retirement (fishing does not count) then this is a heads up to expect to pay some taxes.

Phil Chandler, CPA, MBA is a principal with Leblanc & Chandler, CPA and a speaker, author and consultant on topics regarding tax, bookkeeping, accounting and business management.  His education in accounting and engineering and background in accounting, construction and real estate provide him unique insights in what it takes to run successful businesses, especially in those specific industries.