Social Security

Taxes and Your Social Security

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social security income tax

If you thought Uncle Sam would forget about taxes on your Social Security retirement benefits, think again. When you have other income, up to 85% of your benefit could be taxable. Your “combined income” determines whether — and how much of — your benefits will be subject to federal income tax.

What’s Combined Income?

Your combined income comprises all the income you receive from any source, with only a few exceptions. Combined income includes wages and self-employment income; rental income; investment income, such as interest, dividends, and capital gains; income from pensions and retirement accounts (but not tax-free Roth distributions); and — here’s the kicker — even tax-exempt interest from municipal bonds. In addition, you have to add in half your Social Security benefits when you are figuring your combined income.*

The Thresholds

You won’t pay taxes on your Social Security if:

  • Your combined income is not more than $25,000 and your filing status is single or head of household
  • Your and your spouse’s combined income is not more than $32,000 and you file a joint return

Up to 50% of benefits are taxable if you have combined income between:

  • $25,000 and $34,000 (single/head of household)
  • $32,000 and $44,000 (married joint)

Up to 85% of benefits are taxable if you have combined income of more than:

  • $34,000 (single/head of household)
  • $44,000 (married joint)

And if you’re a married taxpayer filing a separate return, you’ll probably have to pay taxes on your benefits. Connect with us today for all the latest and most current tax rules and regulations.

* You have to take certain adjustments into account in the combined income calculation.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Michigan Pension Tax-Updated

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Historically, Michigan allowed an exemption for pension income.  For those with private pensions (e.g., 401k plan from GM or an Individual Retirement Account), the State allowed a $45,842 exemption in 2011 ($91,684 for joint filers) from taxable income.  For public pensions (i.e., government pensions), the exemption was unlimited—there was no tax on public pension income regardless of amount.

While the pension tax was working its way through the legislative process, the original plan was to subject seniors’ entire pension income to Michigan’s 4.35% income tax.  This caused a bit of a stir.  The pension tax, in its final form, applies different tax rules to three brackets.

The brackets are:

  • Those born before 1946
  • Those born between 1946 and 1952
  • Those born after 1952

On a joint return, it is the year of birth of the older spouse that controls the tax treatment of both spouses’ pensions.

BORN BEFORE 1946

Those born before 1946 will see no change in how their pension income is taxed.  For 2012, private pension income up to $47,309 is exempt for single filers and $94,618 for joint filers.  Public pensions are exempt regardless of amount.  Social Security income is fully exempt from Michigan tax.  Seems simple so far, but wait…

BORN BETWEEN 1946 AND 1952

Phase 1: Before the Taxpayer Reaches Age 67

If a taxpayer is born between 1946 and 1952 and is under 67 years old, the exemption amounts are changed to $20,000 for a single return and $40,000 for a joint return regardless of whether the income is from a private or public pension.  Social Security income is exempt.  Railroad pension income is exempt.  Military pension income is exempt.

Phase 2: After the Taxpayer Reaches Age 67

If a taxpayer is born between 1946 and 1952 and is 67 years old or older, the exemption amounts remain at $20,000/$40,000 but apply to both pension and non-pension income.  This provision helps seniors with low pension income because they now have a large exemption that can apply to non-pension income such as wages or business profit.

Social Security income is fully exempt from Michigan tax.  Social Security income recipients are still eligible to use the $20,000/$40,000 exemption amounts to other types of income.

Recipients of railroad pension income and military pension income have a choice.  They can either:

  • take an unlimited tax exemption for railroad pension income or military pension income OR
  • claim the $20,000/$40,000 exemption amounts

When the law originally passed, the $20,000/$40,000 exemption amounts were completely phased out if Household Resources exceed $75,000 on a single return or $150,000 on a joint return.  However, this phaseout has been ruled unconstitutional by the Michigan Supreme Court because it constitutes a graduated tax.  Michigan’s Constitution requires the state to have a flat income tax.

Born after 1952

Phase 1: Before the Taxpayer Reaches Age 67

If a taxpayer is born after 1952 and is under 67 years old, the new law eliminates any exemption of private or public pension.  Social Security income, Railroad Pension income, and Military pension income are still exempt from Michigan tax.  There is no $20,000/$40,000 exemption available to offset any form of income.

Phase 2: After the Taxpayer Reaches Age 67

If a taxpayer is born after 1952 and is 67 years old or older, the new law allows the $20,000/$40,000 exemption for ALL types of income—public and private pensions, non-retirement income, and Social Security income.

Under this provision, Social Security income, Railroad Pension income, and Military Pension income has to be sheltered by the $20,000/$40,000 exemption amounts.

ALTERNATIVELY:  taxpayers may elect to waive the $20,000/$40,000 exemption amounts and instead claim an unlimited exemption for Social Security income, Railroad Pension income, and Military Pension income.

Example:  It is 2020, John is 67 years old and he was born in 1953.  John has $15,000 in Social Security Income and $30,000 in private pension income.  John is married so he is entitled to a $40,000 exemption.  John must use $15,000 of his exemption to shelter his Social Security income.  John has a $25,000 remaining exemption to shelter his $30,000 pension income.  John will pay tax on the remaining $5,000 pension income.

Under the alternative, John would waive the $40,000 exemption amount and fully exempt his Social Security income.  However, this  would increase John’s taxes.  His Social Security income of $15,000 would be exempt, but he must now pay tax on his $30,000 private pension income.

Basically, taxpayers would be better off claiming the $20,000/$40,000 exemption unless their Social Security income, Military Pension income, and Railroad Pension income are greater than the $20,000/$40,000 exemption amount.

If John was born in 1952, his Social Security income would be exempt from tax without having to use his $40,000 exemption.  Thus, his full $40,000 exemption would fully shelter his $30,000 pension income.

Tax simplification!!!

Stay tuned for more updates.

Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

Payroll Tax Cut Extended

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Quick Background on Payroll Taxes

The Federal Insurance Contributions Act (FICA) imposes two taxes on employers, employees, and self-employed people.  One tax is the Old Age, Survivors and Disability Insurance (OASDI, commonly known as the Social Security tax).  The other tax is for Hospital Insurance (more commonly known as Medicare A).  The Social Security tax has been 6.2% and the Medicare tax has been 1.45%.  An employee pays the 6.2% Social Security Tax on her first $110,100 of wages (this wage base changes periodically), and pays the 1.45% Medicare Tax on all wages without limit.  The employer must match employees’ Social Security and Medicare Tax contributions.  Therefore, the employee pays a combined Social Security and Medicare tax rate of 7.65% of wages and the employer matches this 7.65% contribution for a combined FICA rate of 15.3%.

Self employed people pay both employer and employee portions of the tax on their self employment income.  The self-employment rate has been 15.3%.  There are two adjustments that self employed people make that are related to self employment tax:

  • The first adjustment is to multiply self-employment income by 0.9235. This adjustment basically allows the employer portion of FICA taxes to be deducted from self employment income.  Notice that the 0.9235 number is equal to 1 – 7.65%.  7.65% representing the employer portion of FICA

Example:  Joan has $100,000 of self employment income from her proprietorship.  She multiplies this income by 0.9235 and the product is $92,350, which is equal to her $100,000 self employment income less the employer portion of 7.65%.  The self employment tax rate of 15.3% is then multiplied by $92,350 to arrive at self employment tax of $14,129.

  • The second adjustment is a deduction equal to one-half of the self employment tax on the self employed person’s tax return.

On Joan’s personal tax return, she would be allowed an above the line deduction of $7,064.50 (one half of the $14,129 self employment tax).

What’s New

During 2011, the employee portion of Social Security was reduced to 4.2% from 6.2%.  The Social Security tax for self-employed individuals was 10.4% (6.2% employer portion plus 4.2% employee portion).  In December 2011, when Congress couldn’t agree on how to fund a full-year extension of the payroll tax cut, it passed the Temporary Payroll Tax Cut Continuation Act of 2011 that provided a two month extension of the 4.2% employee Social Security rate.  On February 17, Congress passed the Middle Class Tax Relief and Job Creation Act of 2012.  This new law extended both the 4.2% Social Security employee portion and the 10.4% Social Security portion of self employment tax until December 31, 2012.

The maximum savings for 2012 will be $2,202 (2% of $110,100) per taxpayer.  If both spouses earn at least as much as the wage base, the maximum savings will be $4,404.

An additional change is made for the above the line deduction for self employment tax.  The deduction is normally one half of the self employment tax to reflect the half that represents the employer portion of the tax.  However, the employee portion of the Social Security tax is 4.2% while the employer portion of the Social Security tax is 6.2%.  Thus, the deduction for Social Security tax is now 59.6% [6.2% employer portion divided by combined employer and employee Social Security tax of 10.4%].  The deduction for the Medicare portion of the self employment tax remains at 50% since the 2% reduction applied only to the Social Security Tax.

Example:  It is now 2012 and Joan still has $100,000 in self employment income.  The first adjustment is still to multiply her $100,000 income by 0.9235.  The product of $92,350 is multiplied by the Social Security portion of self employment tax of 10.4% to arrive at $9,604.40.  The $92,350 is also multiplied by the Medicare portion of self employment tax of 2.9% to arrive at $2,678.15 for a total self employment tax of $12,282.55.  Notice that the self employment tax is less than the first example by $1,846.45.  This difference is due to the 2% reduction in the Social Security portion of self employment tax times the self employment income of $92,350.

To calculate Joan’s above the line deduction:

  • multiply the Social Security portion of self employment tax by 59.6% ($9.604.40 times 59.6% equals $5,724.22)
  • multiply the Medicare portion of self employment tax by 50% ($2,678.15 times 50% equals $1,339.08)
  • Joan’s total above the line deduction for self employment tax is $7,063.30.
Thus, Joan has to cut a check for $12,282.55 to cover self employment tax.  The $7,063.30 above the line deduction for self employment tax is multiplied by her individual tax rate to determine its value.  If Joan is in the 30% bracket, the $7,063.30 deduction will reduce her income taxes by $2,118.99.

Buzzkill Disclaimer: This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

Any tax advice contained in the body of this post was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. Any information contained in this post does not fall under the guidelines of IRS Circular 230.

 

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