Taxation of Social Security benefits

The amount of Social Security income which is taxable depends on your taxable income. Most high-income retirees will have 85% of Social Security benefits taxable. For lower-income retirees, less than 85% will be taxable, but many retirees in a 15% tax bracket will face a marginal tax rate much higher than 15%. Social security benefits are also taxable in some states (see Figure 1.)

The formula
The full rules are in IRS Publication 915 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.

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.)

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.

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.

Examples
These examples are based on tax numbers for 2014. They illustrate how tax brackets and Social Security taxation interact, creating a 27.75% marginal tax rate for most taxpayers in the 15% tax bracket, and a 46.25% marginal tax rate for some single taxpayers but only married taxpayers with very high Social Security benefits at the bottom of the 25% bracket.

Single taxpayers:

If you are single and receive $20,000 in Social Security benefits:
 * None of your benefits are taxable if your other income is less than $15,000.
 * For every dollar between $15,000 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 $38,706, which makes the maximum $17,000 taxable.

The table below assumes that you have no dependents (exemption of $3,950) and take the standard deduction ($7,750 for a taxpayer over 65), so your first $11,700 of income is not taxable.

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.

The table below assumes that you have no dependents (exemption of $7,900) and take the standard deduction ($14,800 for a married couple over 65), so your first $22,700 of income is not taxable.

There is no 46.25% rate in this table because the example couple reaches the maximum taxable benefit amount before reaching the 25% tax bracket. With 2014 tax brackets, the 46.25% rate only affects a couple with Social Security of $44,119. With that benefit, $6000 of Social Security would be taxable for other income of $21,940, and every additional $1 would make 85 cents taxable, up to a total income of $59,000, which would make the maximum $37,501 taxable. This gives an adjusted gross income of $96,501, and the last $1 is taxed in the 25% bracket.