How to Gauge Benefits Tax

How-to-Gauge-Benefits-Tax

Some people who begin claiming Social Security benefits are surprised to find out they’re taxed by the federal government on the amounts they receive. If you’re wondering whether you’ll be taxed on your Social Security benefits, the answer is: It depends. Here’s what to know and how to gauge benefits tax.

The taxation of Social Security benefits depends on your other income. If your income is high enough, then between 50 percent and 85 percent of your benefits could be taxed. (This doesn’t mean you pay 85 percent of your benefits back to the federal government in taxes. It merely means that you’d include 85 percent of them in your income subject to your regular tax rates.)

Formulas and Fine Print

To determine how much of your benefits are taxed, first calculate your other income, including certain items otherwise excluded for tax purposes (for example, tax-exempt interest). Add to that the income of your spouse if you file a joint tax return. To this, add half of the Social Security benefits you and your spouse received during the year. The figure you come up with is your total income plus half of your benefits. Now apply the following rules:

  1. If your income plus half your benefits isn’t above $32,000 ($25,000 for single taxpayers), none of your benefits are taxed.
  2. If your income plus half your benefits exceeds $32,000 but isn’t more than $44,000, you will be taxed on one half of the excess over $32,000, or one half of the benefits, whichever is lower.

Here is an example to illustrate:

Let’s say you and your spouse have $20,000 in taxable dividends, $2,400 of tax-exempt interest, and combined Social Security benefits of $21,000. So, your income plus half your benefits is $32,900 ($20,000 + $2,400 + half of $21,000). You must include $450 of the benefits in gross income (½ [$32,900 − $32,000]).

(If your combined Social Security benefits were $5,000, and your income plus half your benefits were $40,000, you would include $2,500 of the benefits in income: ½ [$40,000 − $32,000] equals $4,000, but half the $5,000 of benefits [$2,500] is lower, and the lower figure is used.)

Note: If you aren’t paying tax on your Social Security benefits now because your income is below the floor, or you’re paying tax on only 50 percent of those benefits, an unplanned increase in your income can have a triple tax cost. You’ll have to pay tax on the additional income. You’ll have to pay tax on (or on more of) your Social Security benefits (since the higher your income the more of your Social Security benefits are taxed). And you may get pushed into a higher marginal tax bracket.

For example, this situation might arise if you receive a large distribution from an IRA during the year or if you have large capital gains. Careful planning might avoid this negative tax result. You might be able to spread the additional income over more than one year, or liquidate assets other than an IRA account, such as stock showing only a small gain or stock with gain that can be offset by a capital loss on other shares.

Stay Ahead of the Game

If you know your Social Security benefits will be taxed, you can voluntarily arrange to have the tax withheld from the payments by filing a Form W-4V. Otherwise, you may have to make quarterly estimated tax payments. Keep in mind that most states do not tax Social Security benefits, but 12 states do tax them. Contact the experienced professionals at Ramsay & Associates for assistance on how to gauge benefits tax or for more information on social security benefits.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.

The 2021 “Social Security wage base” is increasing

“Social Security wage base” is increasing

If your small business is planning for payroll next year, be aware that the “Social Security wage base” is increasing.

The Social Security Administration recently announced that the maximum earnings subject to Social Security tax will increase from $137,700 in 2020 to $142,800 in 2021.

For 2021, the FICA tax rate for both employers and employees is 7.65% (6.2% for Social Security and 1.45% for Medicare).

For 2021, the Social Security tax rate is 6.2% each for the employer and employee (12.4% total) on the first $142,800 of employee wages. The tax rate for Medicare is 1.45% each for the employee and employer (2.9% total). There’s no wage base limit for Medicare tax so all covered wages are subject to Medicare tax.

In addition to withholding Medicare tax at 1.45%, an employer must withhold a 0.9% additional Medicare tax from wages paid to an employee in excess of $200,000 in a calendar year.

Employees working more than one job

You may have employees who work for your business and who also have a second job. They may ask if you can stop withholding Social Security taxes at a certain point in the year because they’ve already reached the Social Security wage base amount. Unfortunately, you generally can’t stop the withholding, but the employees will get a credit on their tax returns for any excess withheld.

Older employees

If your business has older employees, they may have to deal with the “retirement earnings test.” It remains in effect for individuals below normal retirement age (age 65 to 67 depending on the year of birth) who continue to work while collecting Social Security benefits. For affected individuals, $1 in benefits will be withheld for every $2 in earnings above $18,960 in 2021 (up from $18,240 in 2020).

For working individuals collecting benefits who reach normal retirement age in 2021, $1 in benefits will be withheld for every $3 in earnings above $46,920 (up from $48,600 in 2020), until the month that the individual reaches normal retirement age. After that month, there’s no limit on earnings.

Contact us if you have questions. We can assist you with the details of payroll taxes and keep you in compliance with payroll laws and regulations.

About the author

Brady is the owner of Ramsay & Associates. He specializes in financial statement preparation and personal, fiduciary and corporate tax and accounting.

His professional experience includes seven years' experience for local and national CPA firms before joining Ramsay & Associates in 2006.

He has a Bachelor of Accounting degree from the University of Minnesota Duluth. He is a Certified Public Accountant, a member of the Minnesota Society of CPA's, an Eagle Scout, as well as an active volunteer in the community.