Friday, June 24, 2011


When unemployment benefits first became taxable I remember turning to my mentor and saying, “Next thing you know they will be taxing Social Security”. I was right!

Social Security and Railroad Retirement Benefits were first taxable up to a maximum of 50% of the benefits paid, based on income. The 50% figure was chosen because one-half of the total Social Security contribution is made by the taxpayer and 50% by the employer. This was eventually increased to a maximum of 85% of benefits paid, taking into account the “accrued earnings” on the contributions.

Currently the taxable portion of Social Security and Railroad Retirement benefits is determined using a complicated formula based on taxable and tax-exempt income and filing status. Under this formula it is possible that each additional $1.00 in income could be taxed as $1.85, and 85 cents of each additional $1.00 of tax-exempt municipal interest would be effectively taxed.

And under the current rules, although we say that capital gains and qualified dividends are taxed at a special 0% or 15% tax rate, these items of income can increase the amount of taxable Social Security and Railroad Retirement benefits, so that the effective tax rate is in reality more than 0% and 15%.

In my new Tax Code I would calculate the taxable portion of Social Security and Railroad benefits in the same manner as any other pension or annuity.

I would use the Simplified General Method to allocate the recovery of employee “after tax” contributions to the Social Security system (employee Social Security tax, but not Medicare tax, withholdings) to each monthly check over a period of time based on the age of the recipient when payments began.

If it was determined that the annual recovery of employee Social Security contributions for a retiree was $3,000, and the total Social Security benefits received for the year was $18,000, then $15,000 would be taxed income, regardless of the amount of the taxpayer’s other taxable and tax-exempt income.

The Social Security Administration has a record of employee contributions and can accurately identify the taxable portion on the Form 1099-SSA, as also can be done with the information return for Railroad Retirement benefits. There would no longer be the need for taxpayers to complete a complicated worksheet to determine the taxable amount.

Determining the taxable portion of Social Security benefits for individuals who had paid “self-employment tax” over the years may be a bit more complicated. The taxable portion of benefits paid to minor children will also be more complicated to determine. But I expect the SSA software can be adjusted to determine the amount to report in these situations.


1 comment:

Anonymous said...

The current taxcode is tough. A retiree can find the next $1000 being taxed at 46.25% (this is 25% * 1.85 and the effect of how SS taxation is phased in. This occers at a low enough level of income that it's painful. The phase-in shouldn't start so low and its level should not be that 85% cut in. Half my tax strategy in November each year is on how to avoid that tax.