Federal SS Taxation Confusion

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vested1
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Federal SS Taxation Confusion

Post by vested1 »

I have read numerous other threads as well as the Wiki on the subject of federal taxation of SS benefits, and I guess I must be dense, because I'm still confused. Or at least I was until I called my daughter, who is a CPA.

This year (2020), almost 5 years into retirement, will be our first full year without a mortgage. Add to that the fact that our gasoline bill has plummeted, as well as our travel expenses and lower taxes due to moving to a LCOL State in mid 2019. This resulted in far less income needed to meet expenses. I try to do my own estimation of what our taxes will be in order to avoid having to file quarterly taxes due to underestimating what we should be paying. I always pay to have our taxes done but may transition to doing them myself for the 2020 tax year.

I was under two erroneous impressions, and may still be corrected here if I'm wrong, which I encourage.

1. Our SS income has always been taxable at 85% of the total combined benefit due to the amount of benefit we receive. This would apply to 100% of the benefit, so for instance $37,000 combined SS benefit, $31,450 taxable. This made sense because that's the way it appeared on all past tax returns since we filed for SS.

Or

2. SS income is incremental in it's tax liability, in that 0 to $12,000 is not taxed, $12,000 to $24,000 is taxed at 50%, with benefit amounts above $24,000 have everything above that base amount (of the benefit) 85% taxable. The wording of every site I visited, including the Wiki, tripped me up.

As it turns out, both impressions are wrong, or partially so. More depends on how much your other income is, and it is more complicated than I had assumed. In past years our entire benefit was 85% taxable because of our much higher other combined income. My daughter walked me through it over the phone and sent me the following IRS publication, which on page 15 provides a worksheet to determine the correct amount of SS taxation in dollars when filled out.

https://www.irs.gov/pub/irs-pdf/p915.pdf

I had tried a number of calculators before talking to my daughter and using the worksheet, with wildly different results. The only one that was accurate and agreed with the IRS worksheet was the one referenced earlier in this thread, at $37,856 total combined benefit and $11,804 taxable. Our combined benefit is from her old age benefit filed at age 65 and my restricted application based on her PIA benefit filed simultaneously at my FRA.

https://www.mortgagecalculator.org/calc ... ulator.php

I'm kind of obsessive about word usage, and my interpretation of the wording in the Wiki, as well as on other sites, lead me down the garden path. I'm not a wizard at spreadsheets either, so my rather rudimentary math skills needed to suffice. The key aspect of determining SS taxability is other income.

The Wiki points you to a calculator which I'm sure will work well for most who are proficient at Excel.

https://www.bogleheads.org/wiki/Taxatio ... y_benefits

My only other advice if you are still having trouble with this, other than using either the linked worksheet or one of the linked calculators, is to encourage your son or daughter to get a CPA certificate, and to stay on good terms with them. :D
jebmke
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Re: Federal SS Taxation Confusion

Post by jebmke »

I didn't follow through all this but the method I use to determine the tax effect on any particular item is to delete it from my tax return and see how much my tax (Line 16) changes. That way all the various interactions of income and taxes, credits, deductions etc are accounted for.
When you discover that you are riding a dead horse, the best strategy is to dismount.
kaneohe
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Re: Federal SS Taxation Confusion

Post by kaneohe »

vested1 wrote: Sun Aug 23, 2020 12:18 pm ..............................................................................
Or

2. SS income is incremental in it's tax liability, in that 0 to $12,000 is not taxed, $12,000 to $24,000 is taxed at 50%, with benefit amounts above $24,000 have everything above that base amount (of the benefit) 85% taxable. The wording of every site I visited, including the Wiki, tripped me up.

................................................................
here is what the wiki had:
"Married taxpayers:

If you are a married couple and receive $40,000 in Social Security benefits:

None of your benefits are taxable if your other income is less than $12,000.
For every dollar between $12,000 and $24,000, an additional 50 cents becomes taxable.
For every dollar over $24,000, an additional 85 cents becomes taxable, up to a total other income of $56,941, which makes the maximum $34,000 taxable."

Possibly you missed the key words "OTHER income" Also that in this specific example only, the couple had 40K
in SS benefits. You also needed to be aware of the general formula in the first paragraph of the wiki:

"The formula
The full rules are in IRS Publication 915.[2][note 1] This simplification covers most cases; there are special rules if you contribute to a Traditional IRA, receive retroactive payments for prior years, or file forms to exempt other income from taxation.[3]

The relevant income for Social Security taxation includes all items which are normally part of your adjusted gross income, plus tax-exempt interest income, plus 50% of your Social Security benefits. (Historically, the 50% represents the fact that half of your Social Security contributions were made by your employer and thus not taxed.)[4]

There are two relevant base amounts; unlike most income limits in the tax code, they are not adjusted for inflation. The lower base is $25,000 if you are single, $32,000 if married filing jointly. The upper base is $34,000 if you are single, $44,000 if married filing jointly.[5]

If your relevant income is below the lower base, none of your benefits are taxable. For every $1 of relevant income between the lower and upper bases, 50 cents of your Social Security benefits become taxable, up to 50% of your total benefits. For every $1 of relevant income above the upper bases, 85 cents of your Social Security benefits become taxable, up to a total taxable amount of 85% of your benefits.[6]"

The "other income" needs to be added to 50% of your SS income to get the "relevant income". If your SS is 40K, then
your "relevant income" is your "other income" plus 20K. If your "other income" is < 12K,your "relevant income" is
< 32K which is the lower base for MFJ , none of your SS benefits are taxable.

The wiki perhaps has the fault that you need to jump back and forth (or up and down) to integrate the process but it seems to all be there if you are slow and careful. I do agree tho that the IRS worksheet which just flows in one direction is a more straight-forward way to doing things.
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Watty
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Re: Federal SS Taxation Confusion

Post by Watty »

vested1 wrote: Sun Aug 23, 2020 12:18 pm 2. SS income is incremental in it's tax liability, in that 0 to $12,000 is not taxed, $12,000 to $24,000 is taxed at 50%, with benefit amounts above $24,000 have everything above that base amount (of the benefit) 85% taxable. The wording of every site I visited, including the Wiki, tripped me up.
The complication is that you not only have a marginal tax rate, but the amount of the Social Security that is taxes also changes as your income goes up.

I agree with prior post that it is easier just to run "what if" scenarios using tax software or web sites like this one to figure out your taxes. Once you have a scenero entered you can just add $100 to your income to see what the tax impact would be.

https://www.olt.com/main/home/taxestimator.asp
rkhusky
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Re: Federal SS Taxation Confusion

Post by rkhusky »

vested1 wrote: Sun Aug 23, 2020 12:18 pm The Wiki points you to a calculator which I'm sure will work well for most who are proficient at Excel.

https://www.bogleheads.org/wiki/Taxatio ... y_benefits
I like the heat maps on the wiki page for quick estimates of marginal tax rates, which is generally what I am interested in when looking at SS taxation. And my other income is in the domain of the heat maps. Presumably if your income is higher, than 85% of SS is taxable, and there are no further funny SS taxation effects.
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#Cruncher
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Re: Federal SS Taxation Confusion

Post by #Cruncher »

vested1 wrote: Sun Aug 23, 2020 12:18 pmThe only [calculator] that was accurate and agreed with the IRS worksheet was the one referenced earlier in this thread [1], at $37,856 total combined benefit and $11,804 taxable.
I've always found using IRS worksheets mind-numbing. The one on page 16 of the SS publication 915 is no exception. I think the following nine row spreadsheet is easier to follow. It implements these steps [2] condensed from the Wiki's Taxation of Social Security benefits:
  • Calculate "Relevant Income" (RI) which equals half of SS benefit plus other income.
  • If RI exceeds the 50% SS threshold ($25,000 single / $32,000 joint), 50% of the excess up to the 85% threshold ($34,000 single, $44,000 joint) is taxable; subject to a maximum of 50% of the SS benefit.
  • If RI exceeds the 85% threshold, 85% of the excess is taxable; subject to a total maximum of 85% of the SS benefit.
The example in column B agrees with page 7 of the SS 915 publication. The example in column C agrees with your case above, vested1.

Code: Select all

Row              Col A     Col B     Col C   Formulas in column B copied to column C
  2        Return type    Single     Joint
  3      50% threshold    25,000    32,000
  4      85% threshold    34,000    44,000
  5         SS benefit     5,980    37,856
  6       Other income    28,990    31,900
  7  "Relevant income"    31,980    50,828  =B6+B5/2
  8     50% SS taxable     2,990     6,000  =MIN(50%*B5,MAX(0,50%*MIN(B7-B3,B4-B3)))
  9     85% SS taxable         0     5,804  =MIN(85%*B5-B8,85%*MAX(0,B7-B4))
 10   Total SS taxable     2,990    11,804  =B8+B9
  1. I don't see the calculator "referenced earlier in this thread".
  2. You also nicely state these rules in your post, vested1.
kaneohe
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Re: Federal SS Taxation Confusion

Post by kaneohe »

#Cruncher wrote: Sun Aug 23, 2020 5:14 pm
vested1 wrote: Sun Aug 23, 2020 12:18 pmThe only [calculator] that was accurate and agreed with the IRS worksheet was the one referenced earlier in this thread [1], at $37,856 total combined benefit and $11,804 taxable.
.........................................
  1. I don't see the calculator "referenced earlier in this thread".
    ..............................................
I think vested1 meant referenced below his statement which is the mortgage calculator
Last edited by kaneohe on Sun Aug 23, 2020 5:53 pm, edited 1 time in total.
kaneohe
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Re: Federal SS Taxation Confusion

Post by kaneohe »

#Cruncher wrote: Sun Aug 23, 2020 5:14 pm ...........................................................................

Code: Select all

Row              Col A     Col B     Col C   Formulas in column B copied to column C
  2        Return type    Single     Joint
  3      50% threshold    25,000    32,000
  4      85% threshold    34,000    44,000
  5         SS benefit     5,980    37,856
  6       Other income    28,990    31,900
  7  "Relevant income"    31,980    50,828  =B6+B5/2
  8     50% SS taxable     2,990     6,000  =MIN(50%*B5,MAX(0,50%*MIN(B7-B3,B4-B3)))
  9     85% SS taxable         0     5,804  =MIN(85%*B5-B8,85%*MAX(0,B7-B4))
 10   Total SS taxable     2,990    11,804  =B8+B9
.........................................................
Your methodology can also be thought of a bar chart which might be easier for some to understand.
Calculate the relevant income (other income + 50% SS). Draw the threshold limits for 50% and 85% SS taxable
(32K and 44K for MFJ). Determine where the top of the bar for relevant income is. If less than 50% threshold,
none of the SS is taxable. If between the 50% and 85% thresholds, half of the amount of the bar exceeding the 50% threshold is taxable SS (subject to a max of 50% of SS). If above the 85% threshold, 85% of the amount of the bar
exceeding the 85% threshold plus 6K (for MFJ which is 50% of the difference between 50% and 85% thresholds)
is taxable SS (subject to a max of 85% of SS). A picture would make this easier than it might sound.....
,
JBTX
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Re: Federal SS Taxation Confusion

Post by JBTX »

I always find this heat map representation of marginal tax rate including SS tax helpful, with SS at the top and regular income down the side. This one is for married filing jointly

Image
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grabiner
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Re: Federal SS Taxation Confusion

Post by grabiner »

vested1 wrote: Sun Aug 23, 2020 12:18 pm I was under two erroneous impressions, and may still be corrected here if I'm wrong, which I encourage.

2. SS income is incremental in it's tax liability, in that 0 to $12,000 is not taxed, $12,000 to $24,000 is taxed at 50%, with benefit amounts above $24,000 have everything above that base amount (of the benefit) 85% taxable. The wording of every site I visited, including the Wiki, tripped me up.
This is a very common misconception; even the IRS publication is misleading. There are two ranges of SS taxation phase-in. In the lower range, every $1 of additional income makes 50 cents of SS taxable, up to a maximum of 50% of SS (which you rarely hit in this range). In the upper range, every $1 of additional income makes 85 cents of SS taxable, up to a maximum of 85% of SS. The IRS says that up to 85% of your SS may be taxable if you are in the upper range, but doesn't explain in the text how this works; you have to go through the worksheet.

And it's not just the IRS. I reported to Vanguard that one of their own publications (on the benefits of QCDs) got this wrong; a retired couple making a QCD rather than taking an RMD would move from the upper to the lower range, and Vanguard incorrectly reported that this would cause the amount of taxable SS to change from 85% to 50%. It would decrease the amount of taxable SS for the couple, and thus give a tax benefit comparable to Vanguard's estimate.
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vested1
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Re: Federal SS Taxation Confusion

Post by vested1 »

Thank you all for your replies. I was a bit embarrassed at missing such an obvious aspect of SS federal taxation (other income) and almost didn't start this thread. I ended up doing so anyway, hoping to save some anguish for those who may have also missed this point.

I'm in the critical stage of closely managing our income for the rest of the year, hoping to keep it under a certain point while not sacrificing the enjoyment of life. I do so to qualify for two years of the reduction of prescription costs for a single prescription by over 6k a year in 2021 and 2022, through the qualification of being under 81k gross income in 2020 in order to receive the same discount card we had prior to transitioning to Medicare, when the discount card became income tested. I can use tax returns from the 2020 tax year as proof of income for 2021 and 2022. We walk the thin line of too much conversion of traditional to Roth while keeping reportable income low enough to qualify for the lowering of prescription costs by 12k over the next two years.

After that I will transition to my own SS benefit at age 70 and our fixed income will rise by about 30k a year, half of that in 2022. Then we will have a different problem, one of too much income that can't be written off. I am instituting other measures to mitigate that as well. The change in the law for the onset of RMD's until the year you turn 72 helps in that regard. I am also keeping the factor of our future "bump" in income that can increase your tax liability when it falls within a certain window in mind, which is detailed in the SS taxation portion of the Wiki.

And we thought retirement would be so simple, didn't we?
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