As you may be well aware, Social Security retirement benefits can be taxable to you, depending upon how much other income you have. What you may not be aware of is how this can seriously increase your tax rate for small amounts of additional income.
Provisional Income
So – in order to calculate how much of your Social Security benefit is taxable, it is necessary to determine the amount of your “provisional income” – which is your Modified Adjusted Gross Income (MAGI) plus 1/2 of your Social Security benefit plus any tax-exempt income you’ve received. If you are married and filing jointly (MFJ) and this amount is greater than $32,000, at least part of your Social Security benefit is taxable. The lower limit for all other filing statuses – single, head of household, qualifying widow(er) and married filing separately while living apart from your spouse – is $25,000. If your filing status is married filing separately and you continue to live with your spouse, the lower limit is zero.
The amounts mentioned above are just the first limit – if your provisional income is above those levels, up to 50% of your Social Security benefit is taxable – that is, added to your gross income. If the provisional income is above $44,000 and your filing status is MFJ, then up to 85% of your Social Security benefit becomes taxable. For all other statuses, provisional income above $34,000 triggers up to 85% taxability on your Social Security Benefit. It’s actually not always fully 85%; rather, it’s 85% of the amount that you’re over the limit or 85% of your Social Security benefit, whichever is less. (see the example below)
The Effect
Where this really hurts folks is when provisional income is just barely above the upper limit. See the example below – this is a married couple who earn a total of $40,000 in income (MAGI), plus a total of $16,000 in Social Security benefits:
| Modified Adjusted Gross Income | $40,000 |
| Plus 1/2 of Social Security Benefit | $8,000 |
| Provisional Income | $48,000 |
| Less base amount | $44,000 |
| Excess above base | $4,000 |
| 85% of excess | $3,400 |
| Plus 50% of the excess above the first base ($6,000) | $9,400 |
| 85% of Social Security Benefit | $13,600 |
| To include in gross income (lesser of previous two above) | $9,400 |
| New Gross Income | $49,400 |
So now watch what happens if these folks earn $1,000 more:
| Modified Adjusted Gross Income | $41,000 |
| Plus 1/2 of Social Security Benefit | $8,000 |
| Provisional Income | $49,000 |
| Less base amount | $44,000 |
| Excess above base | $5,000 |
| 85% of excess | $4,250 |
| Plus 50% of the excess above the first base ($6,000) | $10,250 |
| 85% of Social Security Benefit | $13,600 |
| To include in gross income (lesser of previous two above) | $10,250 |
| New Gross Income | $51,250 |
Normally, when someone of this income level (12% tax bracket) increases their income by $1,000, their tax would only increase by $120 – as you might expect. But with this provision to tax Social Security benefits based upon the provisional income that you bring in, when they add $1,000 to their annual income, their gross income is effectively increased by $1,850. As a result, this $1,000 increase in income has caused an increase in tax of $222 – for a rate of 22.2% on that $1,000 increase!
As you can see, for folks that are right in the edge of these taxation limits, this can be an outrageous impact on financial livelihood. If you happen to be in this position, it might be helpful to plan income (if you can) so that in one year you might not be impacted as much by this taxation, and then take the tax hit the following year. This can only be accomplished if you are somewhat in control of when you earn income or recognize gains.
As your MAGI increases, this effect becomes less and less, but it still is worth paying attention to – if you can plan around it, you might save yourself some extra tax!