Social Security Tax Cliff: Just $1 Could Increase Taxable Income by 35%
According to the Social Security Administration, about 40% of all Social Security recipients pay income taxes on their benefits. Depending on how much you receive in additional income per year, you might be subject to a taxation “cliff” based on certain factors.
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Your level of combined income is what’s used to determine your taxable level, with combined income consisting of your adjusted gross income plus nontaxable interest and half of your Social Security benefits.
Nontaxable interest means non-taxed interest you may receive from investments like U.S. savings bond interest and municipal bond interest. IRA deductions can also be non-taxed depending on the contribution type.
Adjusted gross income is found by subtracting certain deductions from your overall income. Before retirement, these deductions typically include 401(k) contributions, or contributions to accounts like health savings accounts (HSAs) and education. During retirement, though, these deductions dwindle. This, plus half of your total Social Security benefit determines your level of combined income taxable by Social Security.
The “cliff” begins as follows.
The SSA’s guidance on Social Security taxes states that if you file a federal tax return individually, and your combined income is between $25,000 and $34,000, you may have to pay taxes on up to 50% of your Social Security benefits. If your combined income exceeds $34,000, up to 85% of your Social Security benefits is subject to income tax. This means even one dollar above $34,000 makes you subject to taxation.
If you file jointly, and you AND your spouse have a combined income between $32,000 and $44,000, you may have to pay taxes on 50% of your benefits. If your joint combined income exceeds $44,000, up to 85% of your benefits is subject to income tax.
Important to note: no more than 85% of your Social Security benefit will ever be subject to tax.
If you are married, but file separate returns, the SSA claims “you will probably pay taxes on your benefits.”
Income can quickly add up, especially if there are several different sources from other investments. For example, if you are drawing on investment accounts that you have held for years in additional to the Social Security checks you receive each month, it’s very likely your benefits will be taxed. Ideally, Social Security benefits will not be your main source of income regardless, but if they are, then it’s just as likely you won’t be taxed anyway.
Every January, benefit recipients are sent a Form SSA-1099 (Social Security benefit statement) which shows the amount of benefits you received in the previous year. You can use this statement when filing your taxes to find out if your specific Social Security benefits will be taxed.
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