Updated: Taxable Social Security Computation Takes More From Fixed Income Retirees Every Year

[alanmcdonley]

Every year we use the 1040A "Social Security Benefits Worksheet--Lines 6a and 6b" to compute how much of our Social Security benefit is taxable.  In step 10 a "standard deduction" is subtracted - $12,000 if MFJ, or $9,000. 

This value equates to one-half of the 2018 standard deduction and has not been indexed since, even though the standard deduction has risen since introduction. This results in seniors paying tax on an increasing portion of their benefit.  It is a hidden tax increase which only affects Social Security recipients.

What can be done to stop this secret claw back of our social security benefit?

[Tonster521 · Accepted solution]

@alanmcdonley You lost me with the reference to the 2018 Federal Standard Deduction. I am providing a link that will advise of the taxation of SS Benefits https://www.ssa.gov/oact/progdata/taxbenefits.html The 50% taxable provision was established in 1983. The 85% taxable provision was established in 1993. The thresholds were established in those years by Congress and signed by the Presidents in office at those times. Their intent was not to index those thresholds. So, over time, more folks will meet or exceed those thresholds and pay Federal Income Taxes (FIT). It should be noted that any FIT paid at the 50% threshold is returned to the SS Trust. Any FIT paid at the 35% additional threshold is returned to the Medicare Medical Insurance Trust. In effect, you are repaying your SS Benefits and paying a greater premium (contribution) for Medicare Part B. To me, this looks like a backdoor way (using the FIT provisions) for implementing a "needs based" SS Program. BTW, the 50% taxable for Singles threshold is $25,000; and, the 85% taxable is $34,000. There is the $9,000 differential on the SS worksheet. For married, the 50% taxable starts at $32,000; and, the 85% taxable is $44,000. There is the $12,000 differential on the SS worksheet. This $12,000 amount has been the differential since 1993. I do not think you can call this a secret claw back after almost 30 years ( almost 40 years for 50% threshold). There is no correlation to the 2018 Federal Standard Deductible for Married Filing Jointly which is indexed for inflation. I do not believe Congress will do anything to amend the thresholds inasmuch as the taxation of SS Benefits is a significant source of revenue for the SS Program and helps keep SS Benefits as well as Medicare Part B viable. I believe about 50% (approx. 30 million) of SS beneficiaries are paying some amount of FIT on their SS Benefits.Hope this helps.

[GailL1]

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@alanmcdonley wrote:

Every year we use the 1040A "Social Security Benefits Worksheet--Lines 6a and 6b" to compute how much of our Social Security benefit is taxable.  In step 10 a "standard deduction" is subtracted - $12,000 if MFJ, or $9,000. 

This value equates to one-half of the 2018 standard deduction and has not been indexed since, even though the standard deduction has risen. This results in seniors paying tax on an increasing portion of their benefit.  It is a hidden tax increase which only affects Social Security recipients.

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Just for your info - there is no more 1040A - now in use is the 1040SR specifically designed for seniors.

Now to the formula - this calculation isn’t designed to be indexed.  It is working as it is supposed to work - that is to bring in as much money as possible to the SS Trust Funds - BTW, that is where any tax on benefits go - into the SS Trust Fund.

When the TCJA passed in 2017 - they did not change these adjustment figures on this worksheet because the goal is to have as many seniors as possible paying this tax on benefits.

Nothing on this worksheet is indexed by design.  Somewhere I read that 56% of all seniors are now paying some tax on their benefits.  

Thank You for your tax on benefit contribution to the SS Trust Fund and Medicare Part A Trust Fund - 

[Tonster521]

@GailL1 Thanks for pointing out that the additional FIT (35%) is returned to the SS Medicare Trust Part A. I inadvertently stated Medicare Part B. I guess I am commenting on too many Medicare Part B Premium postings and questions. At any rate, folks that exceed the 85% threshold are,in effect, paying a direct Medicare Part B Premium from their SS Benefit payment and an indirect Medicare Part A Premium via their FIT return. I am providing an example for the readers who may not understand the amount of the indirect Medicare Part A premium. Assuming a married filing jointly (MFJ) with $3,000/month SS Benefits ($2,000 Worker, $1,000 Spouse) or $36,000/year is in the 12% Federal Tax Bracket. Also, their combined income places exceeds the 85% threshold. So, 85% of the $36,000 is taxable income or $30,600. At the 12% FIT rate, $3,672 is the federal tax. As I understand the allocation, $2,160 ($18,000 X .12) is returned to the SS Trust and $1,512 ($12,600 X .12) is returned to the Medicare Trust Part A. Folks in higher Federal Tax Brackets will pay greater taxes. There is some logic to the 50% threshold because the SS Benefit is funded by employee/employer 50%/50%. However, IMO, it would be more transparent if the Medicare Part A payroll tax would be increased from time to time to reflect increased medical costs. I believe that payroll tax has been 2.9% (1.45% employee/1.45% employer) for over 30 years. Perhaps a cap could be placed on lower income folks.  

[Tonster521 · Accepted solution]

@alanmcdonley You lost me with the reference to the 2018 Federal Standard Deduction. I am providing a link that will advise of the taxation of SS Benefits https://www.ssa.gov/oact/progdata/taxbenefits.html The 50% taxable provision was established in 1983. The 85% taxable provision was established in 1993. The thresholds were established in those years by Congress and signed by the Presidents in office at those times. Their intent was not to index those thresholds. So, over time, more folks will meet or exceed those thresholds and pay Federal Income Taxes (FIT). It should be noted that any FIT paid at the 50% threshold is returned to the SS Trust. Any FIT paid at the 35% additional threshold is returned to the Medicare Medical Insurance Trust. In effect, you are repaying your SS Benefits and paying a greater premium (contribution) for Medicare Part B. To me, this looks like a backdoor way (using the FIT provisions) for implementing a "needs based" SS Program. BTW, the 50% taxable for Singles threshold is $25,000; and, the 85% taxable is $34,000. There is the $9,000 differential on the SS worksheet. For married, the 50% taxable starts at $32,000; and, the 85% taxable is $44,000. There is the $12,000 differential on the SS worksheet. This $12,000 amount has been the differential since 1993. I do not think you can call this a secret claw back after almost 30 years ( almost 40 years for 50% threshold). There is no correlation to the 2018 Federal Standard Deductible for Married Filing Jointly which is indexed for inflation. I do not believe Congress will do anything to amend the thresholds inasmuch as the taxation of SS Benefits is a significant source of revenue for the SS Program and helps keep SS Benefits as well as Medicare Part B viable. I believe about 50% (approx. 30 million) of SS beneficiaries are paying some amount of FIT on their SS Benefits.Hope this helps.

[ScottM182051]

Why isn't AARP Leading the charge to have  the thresholds indexed for inflation ?

[GailL1]

@ScottM182051 

Because the money that comes from this taxation is used to fund Social Security just like the payroll tax.  AND the Trust Fund needs it to pay full benefits.  

Just think of it as the tax you didn’t have to pay on your employers portion of the payroll tax contribution for you.  Makes me feel a bit better at tax time,  

[alanmcdonley]

Explaining to me that taxing my SS benefit more every year is a good thing because it helps fund Medicare doesn't make me glad it isn't indexed.  I feel taxes are a good concept, but I believe corporations and the folks wealthy enough to figure out how to pay little to no taxes are buying congressional protection for their wealth.  The Democrats want solvent social programs, and the Republicans want a 50% tax cut, so the Democrats concede for token  pennies so the Republicans can walk away with the dollars.

"The lack of an indexing provision for the thresholds was not an oversight by Congress. When the 1979 Advisory Council for Social Security first proposed taxing 50 percent of benefits, there were no taxation thresholds. After this proposal encountered immediate and widespread resistance from Congress, it was suggested by some advocates (see Munnell 1982) that benefit taxation might be made politically more feasible if taxation thresholds were used similar to the ones then in use for the taxation of unemployment compensation. ... By leaving the thresholds unindexed for inflation, they would diminish in importance as the years passed, with the result, as Munnell pointed out, that “as incomes and Social Security benefits increase gradually over time, the revenue gain will approach that of including half of Social Security benefits in taxable income for all retirees." 

Social Security Bulletin l Vol. 56, No. 2 l Summer 1993: 

    Proposals to Modifv the Taxation of Social Security Benefits: Options and Distributional Effects
    by David Pattison and David E. Harrington  

    https://www.ssa.gov/policy/docs/ssb/v56n2/v56n2p3.pdf

So you want me to be happy to contribute while being retired on a fixed income with increasing tax burden and increasing inflation.  I just can't understand how that is good.

[Tonster521]

@alanmcdonley It took me awhile to read and comprehend the link you provided. It supports the concept for indexing even though we know Congress may not move on some form of tax relief. Although not the sole solution to the SS Trust's revenue shortfall, taxing SS Benefits does provide some revenue. As I previously mentioned in my reply to Gail1, there is some logic to including 50% of SS Benefits as taxable income. I believe there were discussions in the 1980's to use an "exclusion approach" which is used for non-qualified annuities, pensions wherein participants contribute to the Pension Fund/Trust (i.e., Civil Service Retirement System), etc. I am not sure why that approach was not used. I can only guess that the SS Program was not encouraging Congress to return any remaining FICA taxes to a single person's estate. Those monies are used as mortality credits which may be substantial; and, because of that, has held the FICA tax to 12.4% (6.2% employee and employer). IMO, the exclusion approach or ratio is the fairest. If one has paid a significant amount of FICA tax over their working career, those monies should be excluded over average life expectancy. Once exhausted, all SS Benefits are taxable. IMO, the 35% additional tax should be addressed by increasing the Medicare portion (2.9% - 1.45% employee/employer) of the FICA tax to 3% or more. By shifting the 35% additional tax to SS Beneficiaries ( with income above the established thresholds) puts the burden on those SS Beneficiaries and gives Employers a pass. I believe Medicare Part A should be funded on a current basis via payroll deduction. Everyone should have some exposure to the ever increasing Part A costs.  

[pt9503 · Accepted solution]

Tonster521 mentioned something that I have been thinking about since I completed my 2022 tax submission.  You mentioned the "exclusion approach" whereby income from annuities and pensions would be excluded from the calculation used to determine the portion of my Social Security income that would be taxable.  I've been considering this because 2022 was the year I first started receiving payments from Social Security.

I wasn't surprised that my SS income was partially taxable (in fact, I agree with the concept of taxing a portion for higher income recipients),  What surprised me was that my other retirement income ( reported on 1099-R forms) was included in the taxability calculation.  I was a bit surprised for two reasons:

1.  The original Social Security Act was implemented specifically to encourage   (you might say strongly encourage) individuals to set back a portion of their earnings during their work years so they would have a safety net when they retired.  So, when the government uses my 1099-R income to determine taxability on my SS income, they are, in effect, penalizing me for doing a good job of setting back money for retirement, which is exactly what the original SS Act encouraged me to do.  So, the person who spends their additional income during their work years instead of setting it back for retirement, get to keep 100% of their SS income, whereas those of us who did what the government asked us to do are penalized.  (Please, keep in mind, I am not talking about folks who did not have extra income to put back.  That I understand and support completely)  

2.  Including my 1099-R income in the taxability calculation seems like a double taxation on my retirement income basis.  For instance, if I am in a 20% tax bracket and 85% of my SS income is taxable, then the IRS will take 20% of my 1099-R income and an additional 17% (0.85 times 0.20)  of my SS income.  (correct me if my math is wrong.)

My other incomes, e.g. wages, interest, stock sales, etc., being included in the taxability calculation makes sense to me, but including my 1099-R income makes it appear like the government is talking out of both sides of their mouth.  On the one hand, they encourage me to put back money for retirement, while on the other hand they take back part of what I receive in Soc Sec.  Sort of like saying, "do exactly what we tell you to do so we can punish you for it".

Just my ramblings......

[Tonster521]

@pt9503 It appears you misinterpreted the "exclusion ratio" approach that I suggested for SS Benefits. Using a non-qualified annuity (funded with after tax dollars) provides a clear example. If one purchases a NQ Annuity for $100,000, at age 65 and has a 20 year life expectancy, that person can exclude $416.66 ($100,000 divided by 240 months) from their monthly amount. So, if the annuity pays $555.66 per month, only $139.00 or about 25% is taxable. The $416.66 is, in effect, a return of your premium/contribution (aka exclusion). The exclusion ratio is about 75%. I have rounded the amounts so other readers may comprehend the concept. If the person lives beyond the estimated 20 year life expectancy, all annuity payments thereafter are 100% taxable.

This may be done with SS Benefits as well. However, the issue that Congress needs to address is how do you allocate any remaining FICA taxes should the SS Beneficiary or their Survivor, if any, die before deducting/excluding all FICA taxes or contributions. Currently, the SS Program keeps any remaining FICA taxes/contributions. 

The "exclusion ratio" approach does not exclude other 1099 R income from your Federal Income Tax (FIT) liability. Unfortunately, folks who have a monthly pension and have saved in a defined contribution plan (i.e.,401 K, 457, 403 B, etc.) will pay more FIT when they exceed the SS taxable thresholds established in 1983 (50% taxable) and 1993 (85% taxable). They are, in effect, repaying their SS Benefits or taking a SS Benefit cut. Call it anyway you want. Hope this helps.

[GailL1]

@pt9503 

The tax on benefits is not an income tax - the amount of tax on benefits which you pay because of your income level (of whatever type) goes into the SS Trust Fund and is now helping it stay solvent.  Does that make you feel any better?

The main purpose of it at the beginning was to even out the money of workers who would pay a portion of their pay while working and receive some of it back when they no longer could work.  In the beginning, Social Security only paid retirement benefits to the primary worker.  Kind of like they pay some public school employees now - they only work 9 months but get 12 months of pay if they choose that method.

The income limits for the taxation of benefits is pretty low so a lot of people pay taxes on their benefits - I kind of think of it as the tax that I owe to the government on the contribution amount of the employer; which was paid on my behalf but not taxed by anybody - not the worker and not the employer.  

The taxation on benefits was designed exactly like it was supposed to - not indexed so that more and more funds will be coming in to Social Security via this method.

And we sure need it now.

[pt9503]

Excuse me if I don't understand, but you feel you owe the government taxes on taxes that were paid by your employer?  You say your employer's contribution was never taxed, but in fact, the whole amount your employer paid was a tax - the Social Security tax.

Therefore, you feel obliged to pay money to the government on behalf of money that someone else paid to the government?  

Interesting logic.  That's like if someone goes to your bank and pays off your home loan, you feel obliged to go to your bank and pay them more money on behalf of the money that was paid by the other person.

[GailL1]

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@pt9503 wrote:

Excuse me if I don't understand, but you feel you owe the government taxes on taxes that were paid by your employer?  You say your employer's contribution was never taxed, but in fact, the whole amount your employer paid was a tax - the Social Security tax.

Therefore, you feel obliged to pay money to the government on behalf of money that someone else paid to the government?  

Interesting logic.  That's like if someone goes to your bank and pays off your home loan, you feel obliged to go to your bank and pay them more money on behalf of the money that was paid by the other person.

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The Employers match contribution portion of your payroll taxes for Social Security and Medicare has never been taxed - not by the employee and not by the employer.    

The Employer match of the employees FICA taxes are just a cost of employment - it is not a tax on the employer - 

Call it whatever - tax or contribution - it is part of the whole employee's compensation but is not taxed to either of the parties - 

Think of it like a deferred pension - that's the logic that was used when the tax on benefits started.

SSA.gov history - Taxation of Social Security Benefits

From the link

This was special treatment for Social Security benefits since most private pensions are partly taxable. In most private pensions, an amount of the pension equal to the contributions made by the worker are tax-free. The amount of such private pensions which exceeds the amount of the worker's contributions, is usually subject to federal income taxes.