Help with social security benefits

Q: My wife and I just received our 2020 tax returns back from our accountant and we were shocked to see how much we owed the federal government. We both started collecting Social Security in 2020. Apparently, we owed money because our Social Security benefits were taxable. This seems unfair as I feel I am being taxed on the same income twice since I paid into Social Security! Can you please explain how it works?

A: Many individuals collecting social security are unaware of the taxability of these benefits. For state purposes, the benefits are NOT taxable. However, the benefits MAY be taxable for federal purposes (not for California) depending upon your filing status and level of income. Like most of the Internal Revenue Code, the rules, regulations and calculations required to arrive at the taxable portion of your benefits can be quite cumbersome. The following hopes to make sense of the rules:

Let’s define the technical terms needed for your calculation: The Provisional Income is the sum of your adjusted gross income, one-half of your social security benefits, and all of your foreign and tax-exempt income. The Base Amount is $32,000 for those married filing jointly, $0 for those married filing separately but lived together during the year and $25,000 for any other filing status.

Finally, the calculation is as follows:

For those with provisional income less than $44,000 for joint filers, or $34,000 for all others, the taxable portion of your social security benefits is equal to the LESSER of one-half of the annual benefits received or one-half of the excess of your provisional income over the applicable base amount. For those of you with higher provisional incomes, there may be additional taxable social security income equal to 85% of your benefits.

For example, Johnny and Rebecca have an adjusted gross income of $26,000 for 2020. Johnny receives social security benefits of $6,000 for the year. The couple also receives $4,000 tax-exempt interest income from municipal bonds. The couple would make the following computation to determine how much (if any) of Johnny’s social security benefits must be included in their gross income:

1. Adjusted Gross Income $26,000

2. Plus: All tax-exempt interest $4,000

3. Modified Adjusted Gross Income $30,000

4. Plus: One-Half of Social Security Benefits $3,000

5. Provisional Income $33,000

6. Less: Base Amount $32,000

7. Excess Above Base Amount $1,000

8. One-Half of Excess Above Base Amount $500

9. One-Half of Social Security Benefits $3,000

10. Amount Includable in Gross Income (lesser of 8 or 9) $500

As you can see, this calculation can be quite confusing. It is especially important for those of you who are required to make quarterly estimated tax payments to understand the effects of your financial decisions on the taxability of your social security benefits. By increasing your taxable income through other sources

(i.e. capital gains, IRA or pension distributions, etc.), you may also be increasing the taxable portion of your social security benefits, and thereby your tax liability. Tax planning is important to both minimize potential underestimation penalties and to avoid overpaying your taxes (tantamount to providing the IRS with an interest-free loan)!