taxable social security | robergtaxsolutions.com

Do I have to pay tax on Social Security?

Photo by Jan Roberg.

People often ask me if their Social Security income is taxable. No, sorry, I just lied. When I finish preparing a tax return for someone on Social Security I’ll often hear, “What do you mean my Social Security is taxable? ” People who say that are usually angry when they say it too. But, for many people, Social Security is taxable.

So how do you tell if your Social Security is going to be taxed? Here’s the quick and dirty way to figure it out. First, take half of all of the Social Security income you get and add that to all of the other income you get. If you’re single and the amount is over $25,000 you’ll start getting hit with tax. If you’re married filing jointly—then you’ll start getting hit at $32,000. If you’re married-filing separately and don’t live apart—then it’s all taxable.

So this can totally mess up your tax rates. For example—let’s say you ‘re currently in the 15% tax bracket and you haven’t crossed into “Taxable Social Security Land” yet, but you’re right on the border. You want to take a really nice vacation and it’s going to cost you $10,000. How much money do you need to take out of your IRA to go on vacation and pay the income tax?

Well, you know you need 15% more for the tax so let’s say you take out $12,000.

$12,000 X 15% = 1800

That means that you’ll have $10,200 for your vacation, right? (12,000 IRA – 1,800 income tax = 10,200 vacation money)

Looks good, except it’s wrong. See, if you’re on that border, then half of the $12,000 is going to go into the taxable Social Security pile. So instead of paying 15% on $12,000 you’re paying 15% on $18,000; that’s another $900 in taxes. ($18,000 X 15% = $2,700 and $2,700 – $1,800 = $900)

Now you don’t have enough money to pay for your vacation. You’ll need to be taking more out of your IRA and then even more of your Social Security will be taxed.

Because taking that distribution makes your Social Security Taxable—your real tax rate is 22.5% instead of 15%.

$2,700 tax divided by $12,000 distribution = 22.5% tax rate

For lots of people, there really isn’t much you can do. If your income is high enough, you’re stuck with your Social Security being taxed and there’s no way out. But for some folks—you can plan ahead to avoid this bumped up tax—or at least try to reduce it. You’ve got to know about the tax though if you’re going to plan ahead for it. If you want help figuring out if your Social Security is taxable, give us a call.

Photo by TaxBrackets.org. You can check out their website by clicking on the photo.

I love tax-free income. The great thing about tax-free municipal bonds is the tax-free part. The downside is that they usually pay a lower interest rate than taxable bonds. For many people, tax-free trumps taxable every time—but you have to be careful because they’re not always the best deal for everybody. This is what you need to know:

1. While municipal bonds are tax-free on your federal return, they may be taxable on your state return. Usually, if the municipal bond is for your own state, then it’s not taxable. For example, here in Missouri, if I buy a bond from St. Louis County—that’s not taxable on my Missouri return. But if I bought a tax-free bond from New Jersey, then I’d pay tax on that interest. Buying at home gives you better bang for your buck.

2. Even though your municipal bond interest isn’t taxable, it could make your Social Security income taxable instead. Say what? That sounds a little crazy, doesn’t it? Let’s say you’re a senior citizen with moderate income. You’ve got your social security check, a small pension, a little interest from a CD and a bank account, and most of your other cash tied up in tax-free municipal bonds. With social security income, you’ve got that funky formula where you take half of the social security and add it to the other income and if it crosses the threshold, then part of your social security benefits become taxable. Are you rolling your eyes yet? The computer does this all for you right? But – and this is the important part—your tax-free municipal bond interest gets added into that equation. If you’re one of those borderline seniors, that tax-free bond isn’t saving you as much money as you thought. You might want to look at other, higher return investments.

3. The dreaded AMT. If you’re a high income earner, tax-free income sounds like a great investment doesn’t it? But you’ve got to be careful if you’re dealing with the Alternative Minimum Tax. If you’re in the AMT zone, you want to stay away from what’s known as a “private activity bond.” A private activity bond is when a company like GM wants to raise money, but instead of GM issuing a bond itself, it has the local government issue a bond for it (for example for building a plant in the area). It’s still a tax-free municipal bond, but it’s actually for a private business so it’s called a private activity bond. If you’re an investor that doesn’t have to pay AMT taxes, you’re fine, you get all the benefits of tax-free income. If you’re paying AMT, then you’ve lost all the benefit of the tax-free income. Private activity bond income is taxable under AMT rules.

With the stock market going crazy and many people turning to bonds, it’s important to know the real tax effects of “tax-free” on your tax return.