Taxation of Social Security retirement benefits isn't as cut and dry as most other types of ordinary income. Sometimes it's taxable, sometimes it isn't. Some common questions amongst retirees are whether or not their Social Security retirement benefit is taxable, and if so, will a Cost-of-Living Adjustment (COLA) increase the amount of their benefit that get's taxed? The answers to those questions are that it depends... There is not a one size fit's all regarding Social Security retirement taxation, so we do our best to break it down below.
Social Security taxation is determined based on income thresholds. The maximum amount of your benefit that can ever be taxed under current law is 85%. If you fall in the 85% threshold, that does not mean that your benefit is taxed at an 85% rate. It means that if your benefit is $20,000, only $17,000 of it is subject to tax determined by whatever tax bracket you are in. While 85% is the maximum amount that can be taxed, the taxation thresholds are 0%, 50%, and 85%, and differ based on filing status and income levels.
The amount of your benefit that is taxable uses a formula to calculate 'combined income.' Combined income is basically 1/2 of your Social Security Benefit, plus other taxable income (i.e. pensions, wages, interest, dividends, capital gains, business income, etc.), plus any tax exempt interest, such as municipal-bonds. The resulting dollar amount is your 'combined income' and used to determine the percentage of your benefit that is subject to taxation.
If your income tax filing status is 'single' and your combined income is less than $25,000, your benefit is not subject to income tax. If your combined income is between $25,000 and $34,000, 50% of your benefit may be subject to taxation, and if your combined income is more than $34,000, 85% of your benefit may be subject to taxation.
If your income tax filing status is 'married filing joint' and your combined income is less than $32,000, your benefit is not subject to income tax. If your combined income is between $32,000 and $44,000, 50% of your benefit may be subject to taxation, and if your combined income is more than $44,000, 85% of your benefit may be subject to taxation.
If your income tax filing status is 'married filing separate' and you lived with your spouse at any time during the tax year, the maximum amount (85%) of your benefit is taxable, regardless of what your combined income is. The rules are different if you are married filing separate and you did not live with your spouse at all during the tax year.
Chances are, unless your combined income falls well below the 0% threshold, an increase in your benefit will likely result in an increase in tax. An issue to consider is if you're right at the 0% to 50%, or the 50% to 85% threshold, you might want to consider doing a tax projection to see if a small COLA increase in your benefit will end up bumping you up into the next higher threshold, and if so, consult with a tax professional to see if there is any tax planning that can be done to reduce your tax burden.
If you enjoy reading IRS Publications, IRS Pub. 915 goes into much more detail on this matter, and has worksheets to assist with your calculations.
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