“Double, double toil and trouble; fire burn and cauldron bubble.” That’s what the witches in Shakespeare’s Macbeth chant. Taxpayers could “get burned” if they earn more than the IRS threshold for Social Security retirement benefit taxation. If a taxpayer earns over a specified amount through wages, self-employment, interest, dividends and other taxable income, he or she may owe taxes.

 

Let’s take a look at the rules and the math.

 

Who Is Taxed?

If your “combined income” (defined below) in 2015 is greater than the following amounts, you may be taxed on your social security benefits:

  • File as “individual” (single) and your combined income is between $25,000 and $34,000: you may have to pay income tax on up to 50 percent of your benefits. If you earn more than $34,000, up to 85 percent of your benefits may be taxable.
  • File a joint return, and you and your spouse have a combined income that is between $32,000 and $44,000: you may have to pay income tax on up to 50 percent of your benefits, If you earn more than $44,000, up to 85 percent of your benefits may be taxable.
  • File as married filing separately: you probably will pay taxes on your benefits.

 

What Income is Taxed?

“Combined income” means your Adjusted Gross Income (AGI) plus tax exempt interest plus ½ of your Social Security benefits. Interestingly, your Traditional IRA distributions are included in your AGI for this calculation, but your Roth IRA distributions are not, making the Roth IRA an even more desirable retirement savings vehicle.

 

How Can I Pay the Tax?

You can pay taxes when you file your return. Or, you can have the taxes withheld from your paycheck, just as was done when you were working, by filling out a form or calling the IRS.

 

How Can I Avoid or Reduce This Tax?

Since the thresholds that are being used are not adjusted for inflation or changes in average wages, more people pay tax on their benefits. Be aware of what income sources will make your benefit taxable. If you continue to work after signing up for Social Security and receive wages or self-employment income, that could push your income over the threshold and make your benefit taxable. Interest, dividends, taxable pension payments, traditional 401(k), Traditional IRAs, and other taxable income could also lead to part of your Social Security benefit being taxable. Tax-exempt interest income, such as interest earned on municipal bonds or U.S. savings bonds, must also be included in the calculation that determines whether your Social Security benefit will be taxable. Money withdrawn from Roth accounts in retirement, which is typically not a taxable event, will not contribute to making your Social Security benefit taxable. It may be a good strategy to delay claiming Social Security benefits and use pretax 401(k) and IRA balances before signing up for Social Security.

 

How Do I Calculate This Tax?

Use this equation to arrive at combined income.

Adjusted Gross Income

+ Nontaxable interest*

+ ½ of Social Security benefits

= Combined Income

*An example of nontaxable interest is municipal bond interest.

 

Why Must We Pay This Tax?

When the Social Security program started in 1935, benefits were not taxed. In 1983, benefits could be taxed at 50%; in 1993 tax rates went to up to 85%. Could tax rates rise again? It’s hard to say. However, we know that the taxation spell has been permanently cast, and taxation of Social Security benefits is probably here to stay.

 

Double, double toil and trouble;

Fire burn and cauldron bubble.

Cool it with a baboon’s blood,

Then the charm is firm and good.