The High Marginal Cost of the Social Security Benefits Tax

In yesterday’s Dallas Morning News, financial columnist Scott Burns discussed the hard-hitting Social Security benefits tax.  Using Turbo-Tax, he demonstrates how middle-income seniors (those earning $41,343 to $77,343) are hit by the tax.  Since the income thresholds are not adjusted for inflation, but Social Security benefits are, more seniors will have pay the tax as time goes on.

For those are not familiar with how the tax works, it is applied to up to 85 percent of an individual’s Social Security benefits.  To determine if an individual must pay the tax, he/she adds up any retirement/investment/wage income received plus one-half of total Social Security benefits received for the year.  If the amount exceeds specific income thresholds, affected retirees must add 50 cents in benefits to their taxable income for every dollar by which their income exceeds a specific threshold until half their benefits are subject to taxation.  For single taxpayers whose income exceeds $25,000 annually 50 percent of their benefits are subject to the tax.  For married taxpayers whose total income exceeds $32,000, up to 50 percent of benefits may be taxable. Thus, when retirees earn $1.00, they must pay taxes on $1.50. As a result, the marginal tax rate on their income is 50 percent higher than for young people with the same income.

As income rises, the tax becomes more onerous. Single retirees with incomes above $34,000 and couples with incomes higher than $44,000 must add 85 cents in benefits to taxable income for every dollar of income above these thresholds until 85 percent of their benefits are subject to the tax. Thus, when these retirees earn $1.00, they must pay taxes on $1.85. As a result, the marginal tax rate on their income is 85 percent higher than for young people with the same income.  In fact, an NCPA analysis found that the marginal tax rate for middle-income seniors can be as high as 46 percent when they are subject to the benefits tax!

But because there is a limit on the proportion of benefits that are taxed, the marginal tax rate peaks for middle-income seniors and then declines for more wealthy seniors.  Simply put, the Social Security benefits tax really sticks it to the middle class.  If Congress and the president truly want to help the middle class, they might want to start by repealing the benefits tax.

Comments (3)

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  1. Joe Barnett says:

    This tax will affect seniors with even modest retirement income from an IRA or 401(k) or annuity. It is really tax a savings.

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