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 The Internal Revenue Service takes it easy when it comes to taxation
of Social Security, and many retirees drop into lower tax brackets
that help soften the tax bite taken from pensions, IRAs dividends
and capital gains. Many states exempt Social Security from taxation,
and a handful exempt all retirement income.
Taxable income does tend to fall in retirement, when wage income
stops. Households headed by individuals over age 65 had an average
adjusted gross income (AGI) of $69,000 in 2013, compared with
$88,000 for households age 55 to 65, according to analysis of
Internal Revenue Service data by the Tax Foundation.
In 2013, about 9.7 percent of households were over age 65 and paid
neither federal income taxes nor payroll taxes, according to the
Urban-Brookings Tax Policy Center. They are part of the 43.3 percent
of all households that had no income tax liability that year -
mostly because they had income too low, or could offset income with
deductions and personal exemptions.
All told, 35 percent of seniors’ taxable income in 2013 came from
traditional pensions, 401(k)s and IRA withdrawals, according to IRS
data. Wages are the second highest category of taxable income - 23
percent - while Social Security accounts for 13 percent. The
remainder of taxable income received by seniors is a mix of
qualified dividends, taxable interest and capital gains.
Taxpayers in the 15 percent bracket or lower do not pay taxes on
long-term capital gains and qualified dividends. This year, that
protects single filers with taxable incomes up to $37,650 and joint
filers earning up to $75,300.
"That means, for example, that a retired couple with $20,000 of
Social Security and $30,000 of qualified dividends owe no income tax
on their 2015 tax return," says Roberton Williams, the center’s Sol
Price fellow.
Seniors also tend to make greater use of itemized deductions than
younger taxpayers, notes Scott Greenberg, an analyst with the Tax
Foundation.
"Taxpayers 65 and older are more likely than average to itemize
deductions, and report higher charitable deductions as a percentage
of their income than other age groups," Greenberg says.
Social Security income is subject to taxation, but 15 percent of
benefits are exempt. And taxes kick in only if your income is above
$25,000 (single filers) or $34,000 (joint filers). As a consequence,
only about half of Social Security beneficiaries paid taxes on their
benefits in 2014, according to the Congressional Budget Office (CBO).
FORMULA FOR FILERS
Here is how the formula works. First, you determine a figure Social
Security calls "combined income" - also sometimes called
"provisional income." This is equal to your adjusted gross income
plus nontaxable interest plus 50 percent of your Social Security.
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Single filers with combined income from $25,000 to $34,000 pay
income tax on up to 50 percent of benefits; for those with income
above $34,000, up to 85 percent of benefits are taxable. Joint
filers with combined income from $32,000 to $44,000 pay income tax
on 50 percent of benefits; income above $44,000 to 85 percent is
taxable.
Beneficiaries receive IRS Form SSA-1099 from the IRS during tax
season, which reports the net benefit subject to tax (after Part B
Medicare premiums have been subtracted).
Income is reported on the 1040 or 1040a forms. Form 1040EZ cannot be
used. The popular tax-filing software programs also have the
capacity to handle Social Security income. You can also ask the
Social Security Administration to withhold taxes when you file for
benefits at rates of 7 percent, 10 percent, 15 percent or 25
percent.
Meanwhile, states are all over the map when it comes to their
policies on taxing retirement income.
Twenty-nine states (including the District of Columbia) that have a
broad-based income tax exempt all Social Security from tax,
according to the Institute on Taxation and Economic Policy (ITEP).
Seven states tax some Social Security benefits but provide an
exemption that is more generous than what is available at the
federal level. Six states tax Social Security benefits using the
federal formula.
And a handful of states that have a broad-based income tax
(Illinois, Mississippi and Pennsylvania) exempt all retirement
income from taxation. Meanwhile, 36 states with an income tax allow
some exemption for private or public pension benefits.
If you are uncertain how your state treats retiree income, check out
ITEP’s state-by-state guide to tax policy (http://bit.ly/1V0Bag7)
(This story has been refiled to fix garbled word in second-to-last
paragraph.)
(Editing by Lauren Young and Andrew Hay)
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