Are you one of those who assumes that Social Security benefit is tax-free? Most retirees find it shocking that Social Security benefits are actually taxable. After all, they have been putting a part of their incomes into this federal fund throughout their career, and it is only natural for them to expect some tax-free income out of it after retirement. Unfortunately, this isn’t the case. For a long time, Social Security benefits were mostly tax-free. But thanks to several Congressional reforms, Social Security benefits are taxed up to 85 percent now. The idea was to gather some extra revenues to boost Medicare. Here is how Social Security income is taxed.
• Social Security benefits are taxed both at the state and the federal levels. About 70 percent of all beneficiaries, however, are still not taxed under the federal law. But if you fall among the rest 30 percent – some 18 million Americans who enjoy an impressive income from sources other than Social Security (interests and dividends, employment income, and self-employment wages) – you will have to pay tax on your benefits.
The tax amount may vary depending on whether you are filing your tax as an individual or jointly with your spouse. Here are the rules:
• Your Social Security benefits will be taxable if you draw a provisional annual income (total gross income minus special deductions) of more than $25,000. If you file the tax jointly with your spouse, the income slab will be $32,000.
• If your income is between $25,000 and $34,000 ($32,000 and $44,000 in the case of joint tax filing with your spouse), you will have to pay a flat 50 percent tax on your benefits. The rest amount comes completely tax-free. If you have an income of more than $34,000 (or $44,000 on a joint return), expect to pay a whopping 85 percent tax on your benefits. To know more about federal income taxes on Social Security benefits, visit the Social Security Administration’s website.
• Most of the states do not impose any tax on Social Security income at all. The 13 states that tax Social Security income include Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia. Some of them follow the same tax structure as the federal government while others follow a different system.
• By using a state-by-state guide on taxes on retirees, you can know how much tax is payable on your Social Security income based on your residency. You can also consult the IRS’s 18-line worksheet to know exactly what portion of your benefits is free of tax and what is taxable. You can also find out the exact amount of your state taxes by directly contacting the state government. Remember, state taxes on Social Security income are revised from time to time; so keep yourself updated on the latest tax policy of your state.
• If you’re receiving Social Security income, collect the Form SSA-1099 at the end of every year. This is a statement which mentions the benefits you received in the previous year and tells you whether you owe any tax on your benefits.
• You can pay the tax at the federal level in two ways. Either make a quarterly payment to the Internal Revenue Service or make an arrangement so that taxes are deducted automatically from your Social Security benefits.
• Follow the same procedure to pay your state taxes on Social Security income, if applicable.
For many retirees, social security benefits make a major component of the retirement income. However, before depending on this particular source of income, find out how much tax you have to pay on your earning. If you find the calculation too overwhelming, take the assistance of a financial planner. He/she can help you chart out various tax-saving plans so that you can optimize your resources at retirement.