01/21/2025
Our last installment of tax questions centers around folks who are drawing benefits from Social Security, and why they sometimes have to pay tax on those benefits. It hardly seems fair, but here's the reasoning behind that ugly tax bill....
Why am I paying tax on my Social Security income? I'm over 65!
It might seem like folks who've made it to what Social Security calls “Full Retirement Age” deserve a break on taxes, but the sad truth is, the IRS doesn't really care how old you are. Tax laws are based solely on income, not age.
We get a lot of questions every year along the lines of “I checked with Social Security to see how much I can make and they said if I stay under the limit, I'm ok. Is that true?” We always answer, “Sure, it's true on one hand---but that ONLY applies to the Social Security rules. The IRS doesn't have the same guidelines, so what works for SSA might not work for IRS.”
It's usually at this point that confusion ensues, so we wanted to take a second to try and clear up the matter for folks who might need to know.
Imagine the SSA and the IRS as 2 buckets---SSA's is green and IRS's is red. The kind of income you have is sorted into the buckets.
SSA benefits go into the green one, including benefits for disability. Interest and dividends, wages from a job, retirement benefits, profits from asset sales, your family farm, your small business, or your rental property all go into the red bucket. [Anything in that red bucket gets counted (and probably taxed!) when you file a return.]
Now imagine a white line on the side of the red bucket that represents the income limit SSA says you can have per year. (This line will scoot up a little bit higher on the side of the red bucket in the year you reach full retirement age.)
If your income contributions to the red bucket fill it up past that white line, SSA is going to dip into your green bucket and take money back. If your income doesn't reach the white line, you don't lose anything from the green bucket—SSA doesn't take any of your benefits back if you don't earn “too” much. Furthermore, once you hit that full-retirement age, the white line just disappears—you can fill your red bucket up as much as you want, and SSA won't dip into your green bucket at all. This is how the SSA side of earnings limits work, in a nutshell.
For the IRS's side of the earnings rule, imagine that red bucket has a black line on the side—and it's not in the same place as the white line—it's usually a bit closer to the top. If your income in the red bucket creeps up to that black line, IRS can dip into your green bucket and pull money over into the red one. Remember, anything in that red bucket gets counted when you file a return. This is how you end up paying tax on your Social Security benefits. Be careful too, because if your regular income hits that black line and blows right past it, IRS can siphon up to 85% of the money in your green bucket over into the red one!
If a married couple has one spouse working and the other drawing disability, the same rules apply. If the working spouse's earnings, plus any other “red bucket” income amounts, meet or pass the black line, the disabled spouse's benefits get sucked over into the red bucket too and added into their total taxable income.
There are lots of rules and calculations to figure out where the black line falls on the red bucket, and your filing status can even play a part in that. You can read all the rules for yourself by visiting https://www.irs.gov/newsroom/irs-reminds-taxpayers-their-social-security-benefits-may-be-taxable.
