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Bogleheads
Investing Advice Inspired by Jack Bogle
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neverknow
Joined: 05 Jun 2009
Posts: 1837
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 Posted: Fri Sep 04, 2009 7:03 am Post subject: |
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| jwvanhoven wrote: | | There seems to be a lot of misunderstanding when it comes to taxes on SS. Up to 85% of SS will be taxed if your total income exceeds a certain amount. (see IRS worksheets) It does not increase your tax rate on other income. |
This is true. But if your other income causes your Social Security to be taxed, when it wouldn't be taxed if not for that other income, you are effectively paying double the tax on the other income.
I was wondering last night - does anyone know? Haven't we already paid tax on the income, our Social Security contributions (FICA tax) were made on? Like already taxed money, contributing to an annuity, and then the annuity payout then gets taxed again?
Not unlike the corporation who pays taxes, and then distributes dividends - then you the recipient of the dividends, pays tax on that money again?
Same money, taxed twice, doesn't seem right to me. On the other hand the free money the government has mailed out in this decade, that is not taxed at all, has also seemed strange. Since when does the government ever pass up the chance to tax anything?
Why is the amount of money you earn in a TIP, for instance, that merely keeps pace with inflation taxed? This is not income. It is what you have to do, to keep up with the results of monetary and fiscal policy.
You can not predict future taxation policies. You just pay.
neverknow |
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OAG
Joined: 03 Mar 2007
Posts: 338
Location: Currently Central Ohio, USA
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| Posted: Fri Sep 04, 2009 8:32 am Post subject: |
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The fact used to tax SS in the first round (50% SS Taxed) was that while the contributions by the employee had been taxed that the contributions by the EMPLOYER had not been taxed. Of course they came up with another "fact" (which I am not clear as to what it was) to get it up to 85% taxable. Must have been something along the lines of "some people have more than enough income so lets get some of it back". Also taxation of SS benefits CAN put you in a higher bracket although it would be the taxation of the benefits that will increase while the underlying income, that gets you to the top of the next lower bracket, would not be taxed any differently due to the SS Benefit.
_________________
OAG=Old Army Guy. Retired from USA (US Army) in 1979. |
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pshonore
Joined: 28 Jun 2009
Posts: 878
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| Posted: Fri Sep 04, 2009 8:51 am Post subject: |
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| OAG wrote: | | The fact used to tax SS in the first round (50% SS Taxed) was that while the contributions by the employee had been taxed that the contributions by the EMPLOYER had not been taxed. Of course they came up with another "fact" (which I am not clear as to what it was) to get it up to 85% taxable. Must have been something along the lines of "some people have more than enough income so lets get some of it back". Also taxation of SS benefits CAN put you in a higher bracket although it would be the taxation of the benefits that will increase while the underlying income, that gets you to the top of the next lower bracket, would not be taxed any differently due to the SS Benefit. |
Aren't Cap Gains in the 15% bracket (currently taxed at 0%) an exception to this?? If you decide to take SS and have enough taxable SS to move you into the 25% bracket, the formerly taxed 0% cap gains get taxed at 15% |
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alvinsch
Joined: 19 Feb 2007
Posts: 1575
Location: Northwest
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| Posted: Fri Sep 04, 2009 10:23 am Post subject: |
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| jwvanhoven wrote: | | There seems to be a lot of misunderstanding when it comes to taxes on SS. Up to 85% of SS will be taxed if your total income exceeds a certain amount. (see IRS worksheets) It does not increase your tax rate on other income. |
SS taxation increases one's marginal tax bracket. That does affect the marginal rate that one's regular income is taxed. In the turbotax example I showed it raised one's marginal tax bracket to 46.25% from 25.0%. So if one had another $10000 in ordinary income your taxes increase by $4625. To claim that SS does not increase your tax rate is a misunderstanding in my opinion.
| OAG wrote: | | Also taxation of SS benefits CAN put you in a higher bracket although it would be the taxation of the benefits that will increase while the underlying income, that gets you to the top of the next lower bracket, would not be taxed any differently due to the SS Benefit. |
It's a bit of semantics but I think it is misleading to say that the underlying income taxation isn't affected by SS taxation. If I decide to increase my itemized deductions by giving an extra $1000 to charity that would reduce my taxes on the underlying income by roughly $462.5 in this example instead of $250 in the case where SS didn't increase ones marginal tax rate. So in this case the underlying income is affected by the SS taxation.
All these phaseouts, non tax SS phaseout, CG/QDI phaseout, exemption phaseouts, itemized deduction phaseout, etc., all have the same affect of increasing (sometimes dramatically), ones effective marginal tax rate in the phaseout range. If the charitable deduction and mortgage deductions are also phased out or limited to the 28% bracket to those making more than $200k, as has been proposed by POTUS, the marginal tax rates will skyrocket even higher. It all makes the published tax rates pretty meaningless as the real tax rates are being purposely hidden.
- Al |
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neverknow
Joined: 05 Jun 2009
Posts: 1837
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| Posted: Fri Sep 04, 2009 10:30 am Post subject: |
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| OAG wrote: | | The fact used to tax SS in the first round (50% SS Taxed) was that while the contributions by the employee had been taxed that the contributions by the EMPLOYER had not been taxed. |
Thank you, OAG - I hadn't thought of that. I easily recognize it to be true, as we have filed small business taxes for more then a decade. Indeed - 50% of those FICA taxes is deducted from income (and the small business owner pays both parts - employer and employee, but the employer part is deductible).
neverknow |
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JW Nearly Retired
Joined: 16 Dec 2007
Posts: 1137
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| Posted: Sat Sep 05, 2009 1:01 pm Post subject: |
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| alvinsch wrote: | | SS taxation increases one's marginal tax bracket. That does affect the marginal rate that one's regular income is taxed. In the turbotax example I showed it raised one's marginal tax bracket to 46.25% from 25.0%. So if one had another $10000 in ordinary income your taxes increase by $4625. To claim that SS does not increase your tax rate is a misunderstanding in my opinion. |
Exactly. Seeing how it increases your tax bracket is not obvious but it amounts to a heck a lot more then just bumping you into the next normal tax bracket. I spent some time trying to understand this by working with the 1040 form worksheet by pencil/paper. I gave that approach up thinking that the IRS has so obfuscated this calculation that no one can get their arms around what it does easily.
I'll be the first to admit it was pretty compulsive, but I ended up translating the 1040 worksheet onto a spreadsheet, along with a 1040 tax calculation. Applying this to a range of incomes shows how it works pretty well. A graph of the results is shown below.
Bottomline effect is: until you reach 85% of SS being taxable, it boosts your effective marginal tax brackets applied to the taxable income on line 43 of your 1040 from the nominal 10%, 15%, 25% values. New brackets are: 10% is mostly the same, 15% gets split into 22.5% and 27.75%, 25% becomes 46.25%. If your income is in these brackets, that is what you will pay on the next increment of income.
Assumptions:
Single filer of full retirement age with $20000 SS income and other taxable income varying from $5000 up to $45000 in $1000 increments. Filer takes the std deduction and 1 exemption. This takes the filer from the income range where there are zero taxes on the SS up beyond where 85% is taxed and his marginal rate goes back to "normal".
JW
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DickBenson
Joined: 08 Apr 2007
Posts: 525
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| Posted: Sat Sep 05, 2009 6:23 pm Post subject: |
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| JW Nearly Retired wrote: | | I spent some time trying to understand this by working with the 1040 form worksheet by pencil/paper. I gave that approach up thinking that the IRS has so obfuscated this calculation that no one can get their arms around what it does easily. |
I also tried the pencil/paper approach and obtained a chart somewhat similar to yours. However, the tedious paper/pencil calculations, and my lack of programming skills, prevented me from investigating the impact of various data choices.
As you are aware, tax-exempt income also triggers the taxation of SS. Believe it would be of interest to many retirees, if you could post the same chart, but with the addition of say $5,000 in tax exempt income.
The issue I am struggling with is the plus and minuses of going tax-exempt, tax deferred, or taxable, with respect to SS taxation. If your total income forces 85% of SS to become taxable, there would be no issue. But am curious about the impact of tax exempt income which would still keep less than 85% of your SS taxed.
Dick |
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pshonore
Joined: 28 Jun 2009
Posts: 878
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| Posted: Sat Sep 05, 2009 7:11 pm Post subject: |
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| Not sure if this is what you're asking, but tax-exempt income is treated the same as any other income for purposes of figuring SS taxability. Just add it into the total of 1/2 SS + all other income per the 1040 instruction booklet |
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DickBenson
Joined: 08 Apr 2007
Posts: 525
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| Posted: Sat Sep 05, 2009 8:05 pm Post subject: |
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| pshonore wrote: | | Not sure if this is what you're asking, but tax-exempt income is treated the same as any other income for purposes of figuring SS taxability. Just add it into the total of 1/2 SS + all other income per the 1040 instruction booklet |
However, the addition (or substitution for taxable income) of tax-exempt income can cause SS to become taxable when in different tax brackets. It is this impact that is of interest to me.
Dick |
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JW Nearly Retired
Joined: 16 Dec 2007
Posts: 1137
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| Posted: Sun Sep 06, 2009 8:56 am Post subject: |
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| pshonore wrote: | | Not sure if this is what you're asking, but tax-exempt income is treated the same as any other income for purposes of figuring SS taxability. Just add it into the total of 1/2 SS + all other income per the 1040 instruction booklet |
Whoooa, where does it say that? I don't believe that is correct. The worksheet instructions for line 3 say "Enter the total of the amounts from Form 1040, lines 7, 8a, 9a, 10 through 14, 15b, 16b, 17 through 19, and 21". That omits the tax exempt interest line 8b. Am I missing something?
If it doesn't enter into the SS taxation calculation, my spreadsheet doesn't change. You just have to consider the X-axis not to include any tax free interest.
This means that if you have the misfortune to have an income level to be in the 46.25% bracket ($32-39K in my plot), swapping taxable bonds for tax free bonds is clearly a good idea. If it was me, I would sell enough taxable to get down to the top of the 27.75% effective bracket. However, I'm not a tax advisor so please anyone considering doing this get a 2nd opinion.
Also, remember the above plot is for a specific case. The boundaries of the effective brackets will change depending on your exact circumstances.
If there are any pitfalls to this someone please point them out.
JW
edit......... pshonore pointed out the pitfall, line 4. Tax exempt is included.
Last edited by JW Nearly Retired on Sun Sep 06, 2009 9:23 am; edited 2 times in total |
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pshonore
Joined: 28 Jun 2009
Posts: 878
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| Posted: Sun Sep 06, 2009 9:02 am Post subject: |
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| JW Nearly Retired wrote: | | pshonore wrote: | | Not sure if this is what you're asking, but tax-exempt income is treated the same as any other income for purposes of figuring SS taxability. Just add it into the total of 1/2 SS + all other income per the 1040 instruction booklet |
Whoooa, where does it say that? I don't believe that is correct. The worksheet instructions for line 3 say "Enter the total of the amounts from Form 1040, lines 7, 8a, 9a, 10 through 14, 15b, 16b, 17 through 19, and 21". That omits the tax exempt interest line 8b. Am I missing something?
If it doesn't enter into the SS taxation calculation, my spreadsheet doesn't change. You just have to consider the X-axis not to include any tax free interest.
This means that if you have the misfortune to have an income level to be in the 46.25% bracket ($32-39K in my plot), swapping taxable bonds for tax free bonds is clearly a good idea. If it was me, I would sell enough taxable to get down to the top of the 27.75% effective bracket. However, I'm not a tax advisor so please anyone considering doing this get a 2nd opinion.
Also, remember the above plot is for a specific case. The boundaries of the effective brackets will change depending on your exact circumstances.
If there are any pitfalls to this someone please point them out.
JW |
Line 4 of the instructions:
4. Enter the amount, if any, from Form 1040, line 8b .
(Line 8b is tax exempt interest) |
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JW Nearly Retired
Joined: 16 Dec 2007
Posts: 1137
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| Posted: Sun Sep 06, 2009 9:21 am Post subject: |
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| pshonore wrote: | Line 4 of the instructions:
4. Enter the amount, if any, from Form 1040, line 8b .
(Line 8b is tax exempt interest) |
Oops! Thanks for the quick response.
JW |
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JW Nearly Retired
Joined: 16 Dec 2007
Posts: 1137
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| Posted: Mon Sep 07, 2009 9:16 am Post subject: |
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| DickBenson wrote: | As you are aware, tax-exempt income also triggers the taxation of SS. Believe it would be of interest to many retirees, if you could post the same chart, but with the addition of say $5,000 in tax exempt income.
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OK, I did it for the same "other income" range but instead of all-taxable I subsituted $5K of tax-exempt, and then a 2nd case with $10K exempt. The results are interesting. By substituting enough tax-exempt, my example taxpayer can use up their SS taxibility in lower brackets so they avoid getting into the 46% area. The 46% bracket shrinks in size. The graphs below also include a plot with taxes paid as a function of other income.
The taxpayer with $10K exempt pays lower taxes at all incomes.
Example tax paid for $40K "other income"
All-taxable pays $8356 tax, left after tax = $31644
$10K exempt pays $5856 tax, left after tax = $34144
Does this means that taxpayer with all-taxable should convert some of it to tax-exempt by selling taxable income assests? Maybe, but you need to consider that to buy tax-exempt bonds yielding $10K of income, you will have to give up more than that in taxable income. I'm estimating about 20% more at current 10-year bond yields. So if taxpayer with $40K all-taxable income converts $10K of income to tax-exempt, his other income total will drop to $38K.
With $38K "other income" my graph shows,
$10K exempt pays $5206 tax, left after tax = $32794
So this example taxpayer would get $32794-$31644 = $1150 more after-tax income by converting to $10K of tax-exempts.
I think my results are accurate but there could be errors. Any new calculation like this has bugs as often as not. At least my stuff does. Please do not rely on it to be gospel, it may be crap. By far the best way to evaluate a personal situation is to use commercial tax-software with last year's data and do what-if scenarios.
JW
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Benn1950
Joined: 08 Jan 2009
Posts: 24
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| Posted: Mon Sep 07, 2009 10:50 am Post subject: Roth Distributions & Impact on SS Distribution Tax |
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Do Roth distributions count as income when computing tax level of SS distributions?
Jack |
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livesoft
Joined: 01 Mar 2007
Posts: 12466
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| Posted: Mon Sep 07, 2009 11:13 am Post subject: |
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Thanks for posting all the charts.
From some folks I get the hint that they think they are in the 46+% marginal income tax bracket simply because they have more than $40K in other income. The reality is: they are in the 25% marginal income tax bracket.
Also note one gets an increased standard deduction if they are 65 or older, right? I guess that's in the charts since you wrote "full retirement age".
Thanks again! |
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earlyout
Joined: 20 Feb 2007
Posts: 381
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| Posted: Mon Sep 07, 2009 11:25 am Post subject: Re: Roth Distributions & Impact on SS Distribution Tax |
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| Benn1950 wrote: | Do Roth distributions count as income when computing tax level of SS distributions?
Jack |
Roth distributions do not count as income in this calculation. Roth distributions are included on line 15a but not 15b of form 1040 and the amount from 15a is not entered on the SS Benefits worksheet.
EO |
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JW Nearly Retired
Joined: 16 Dec 2007
Posts: 1137
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| Posted: Mon Sep 07, 2009 12:08 pm Post subject: |
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| livesoft wrote: | Also note one gets an increased standard deduction if they are 65 or older, right? I guess that's in the charts since you wrote "full retirement age".
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Nope, I missed that. The extra $1350 deduction will shift the charts a little. My "full retirement age" comment was intended to make clear this had nothing to do with SS benefits being taken away because of earning too much.
JW |
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Robert Hoolko
Joined: 30 Mar 2007
Posts: 38
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| Posted: Mon Sep 07, 2009 2:02 pm Post subject: |
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JW
I think you have some flaws in your Exempt charts. I have a spreadsheet that plots the same charts. Mine are for joint return and include state tax but do not include exempt income so I cannot compare the numbers but I can see some oddities.
The green and red lines have to be identical until the first dollar of SS is taxed, as they are on your original chart but not on the exempt charts.
Once the first dollar of SS is taxed, it is taxed at 50 cents per dollar for the next $9000 of other income then at 85 cents per dollar for the next $15000 of other income. (for $20000 SS) It is easy to see that on the $10000 exempt chart that there is not $9000 between the jumps to 50 cents and 85 cents.
I don't know how much effect this has on your final results but something is a bit off.
Robert |
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JW Nearly Retired
Joined: 16 Dec 2007
Posts: 1137
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| Posted: Mon Sep 07, 2009 4:08 pm Post subject: |
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| Robert Hoolko wrote: | I don't know how much effect this has on your final results but something is a bit off.
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Thanks Robert, I see my error. I will see if I can fix it.
I told you it might be crap.
edited later...... What I thought was wrong was OK. I checked it in several places just using the worksheet...... can't find anything wrong with it except for using the under 65 number for the over 65 exemption. Maybe there is some other problem but I can't find it.
The plots don't show step breaks in the brackets because I'm just using $1000 income increments. It typically misses/straddles the tax rate table breaks.
JW |
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Robert Hoolko
Joined: 30 Mar 2007
Posts: 38
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| Posted: Mon Sep 07, 2009 6:27 pm Post subject: |
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JW
Look at the red line in the $10000 exempt chart. Count the ticks from where the line first reaches 15% to the last tick before it rejoins the green line. There are 21 ticks, $21,000. It should be 24. You are not taxing the full 85% of the SS.
Straddling a break accounts for it taking two ticks to make a step but it does not reduce the number of ticks.
Robert |
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kaneohe
Joined: 22 Sep 2008
Posts: 842
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| Posted: Mon Sep 07, 2009 8:09 pm Post subject: |
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| Robert Hoolko wrote: |
Once the first dollar of SS is taxed, it is taxed at 50 cents per dollar for the next $9000 of other income then at 85 cents per dollar for the next $15000 of other income. (for $20000 SS)
Robert |
Robert,
I don't think the statement above is quite right. 50% of the SS income is taxed if a certain sum of income (including muni interest and 50% of SS income) is within certain limits and
85% of part of that SS income is taxed if that income exceeds some limit but the tax rates themselves are not 50%/85%.
Perhaps you didn't mean that the rates are 50%/85% but the words kind of sound like that. |
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JW Nearly Retired
Joined: 16 Dec 2007
Posts: 1137
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| Posted: Mon Sep 07, 2009 8:55 pm Post subject: |
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| Robert Hoolko wrote: | Look at the red line in the $10000 exempt chart. Count the ticks from where the line first reaches 15% to the last tick before it rejoins the green line. There are 21 ticks, $21,000. It should be 24. You are not taxing the full 85% of the SS.
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I count 22 ticks above the green line, the first at 18,000 and the last at 39,000. SS starts making a contribution toward taxable income [worksheet line 18] earlier at "other income"= 16,000, but that point and 17,000 are both on the green line because after std deductions, there was zero taxable income. That makes your 24 ticks.
JW |
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Robert Hoolko
Joined: 30 Mar 2007
Posts: 38
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| Posted: Tue Sep 08, 2009 12:50 pm Post subject: |
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JW
| Quote: | | Perhaps you didn't mean that the rates are 50%/85% but the words kind of sound like that. |
I guess my description was not very clear. I meant that in a certain income range each additional dollar of other income causes an extra 50 cents of SS to be taxed (worksheet line 13) and then in a higher income range each additional dollar of other income causes an extra 85 cents of SS to be taxed (worksheet line 17).
| Quote: | | SS starts making a contribution toward taxable income [worksheet line 18] earlier at "other income"= 16,000, but that point and 17,000 are both on the green line because after std deductions, there was zero taxable income. That makes your 24 ticks. |
OK, with my numbers I never encountered a case where any of the SS was taxed at the 0% rate, so It never occurred to me that it might happen. Sorry for the confusion.
Robert |
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