You may have to pay tax on Social Security benefits

pay tax on social security benefits

During your working days, you pay Social Security tax in the form of withholding from your salary or self-employment tax. And when you start receiving Social Security benefits, you may be surprised to learn that some of the payments may be taxed.

If you’re getting close to retirement age, you may be wondering if your benefits are going to be taxed. And if so, how much will you have to pay? The answer depends on your other income. If you are taxed, between 50% and 85% of your payments will be hit with federal income tax. (There could also be state tax.)

Important: This doesn’t mean you pay 50% to 85% of your benefits back to the government in taxes. It means that you have to include 50% to 85% of them in your income subject to your regular tax rates.

Calculate provisional income

To determine how much of your benefits are taxed, you must calculate your provisional income. It starts with your adjusted gross income on your tax return. Then, you add certain amounts (for example, tax-exempt interest from municipal bonds). Add to that the income of your spouse, if you file jointly. 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 provisional income. Now apply the following rules:

  • If you file a joint tax return and your provisional income, plus half your benefits, isn’t above $32,000 ($25,000 for single taxpayers), none of your Social Security benefits are taxed.
  • If your provisional income is between $32,001 and $44,000, and you file jointly with your spouse, you must report up to 50% of your Social Security benefits as income. For single taxpayers, if your provisional income is between $25,001 and $34,000, you must report up to 50% of your Social Security benefits as income.
  • If your provisional income is more than $44,000, and you file jointly, you must report up to 85% of your Social Security benefits as income on Form 1040. For single taxpayers, if your provisional income is more than $34,000, the general rule is that you must report up to 85% of your Social Security benefits as income.

Caution: 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% of those benefits, an unplanned increase in your income can have a significant tax cost. You’ll have to pay tax on the additional income, you’ll also have to pay tax on (or on more of) your Social Security benefits, and you may get pushed into a higher tax bracket.

For example, this might happen if you receive a large retirement plan distribution during the year or you receive large capital gains. With careful planning, you might be able to avoid this tax result.

Avoid a large tax bill

If you know your Social Security benefits will be taxed, you may want to voluntarily arrange to have tax withheld from the payments by filing a Form W-4V with the IRS. Otherwise, you may have to make estimated tax payments.

Contact us to help you with the exact calculations on whether your Social Security will be taxed. We can also help you with tax planning to keep your taxes as low as possible during retirement.

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.

Charitable lead trusts offer philanthropic and family benefits

Charitable lead trusts

Affluent families who wish to give to charity while minimizing gift and estate taxes should consider a charitable lead trust (CLT). These trusts are most effective in a low-interest-rate environment, so conditions for taking advantage of a CLT currently are favorable. Although interest rates have crept up a bit in recent years, they remain quite low.

CLTs come in two flavors

A CLT provides a regular income stream to one or more charities during the trust term, after which the remaining assets pass to your children or other noncharitable beneficiaries.

There are two types of CLTs: 1) a charitable lead annuity trust (CLAT), which makes annual payments to charity equal to a fixed dollar amount or a fixed percentage of the trust assets’ initial value, and 2) a charitable lead unitrust (CLUT), which pays out a set percentage of the trust assets’ value, recalculated annually. Most people prefer CLATs because they provide a better opportunity to maximize the amount received by the noncharitable beneficiaries.

Typically, people establish CLATs during their lives because it allows them to lock in a favorable interest rate. Another option is a testamentary CLAT, or “T-CLAT,” which is established at death by your will or living trust.

Interest matters

Why are CLATs so effective when interest rates are low? When you fund a CLAT, you make a taxable gift equal to the initial value of the assets you contribute to the trust, less the value of all charitable interests. A charity’s interest is equal to the total payments it will receive over the trust term, discounted to present value using the Section 7520 rate, a conservative interest rate set monthly by the IRS. As of this writing, the Sec. 7520 rate has fluctuated between 2.8% and 3.4% this year.

If trust assets outperform the applicable Sec. 7520 rate (that is, the rate published in the month the trust is established), the trust will produce wealth transfer benefits. For example, if the applicable Sec. 7520 rate is 2.5% and the trust assets actually grow at a 7% rate, your noncharitable beneficiaries will receive assets well in excess of the taxable gift you report when the trust is established.

Act now

If a CLAT appeals to you, the sooner you act, the better. In a low-interest-rate environment, outperforming the Sec. 7520 rate is relatively easy, so the prospects of transferring a significant amount of wealth tax-free are good. Contact us with questions.

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.

Thinking about moving to another state in retirement? Don’t forget about taxes

retiring to another state

When you retire, you may consider moving to another state — say, for the weather or to be closer to your loved ones. Don’t forget to factor state and local taxes into the equation. Establishing residency for state tax purposes may be more complicated than it initially appears to be.

Identify all applicable taxes

It may seem like a no-brainer to simply move to a state with no personal income tax. But, to make a good decision, you must consider all taxes that can potentially apply to a state resident. In addition to income taxes, these may include property taxes, sales taxes and estate taxes.

If the states you’re considering have an income tax, look at what types of income they tax. Some states, for example, don’t tax wages but do tax interest and dividends. And some states offer tax breaks for pension payments, retirement plan distributions and Social Security payments.

Watch out for state estate tax

The federal estate tax currently doesn’t apply to many people. For 2019, the federal estate tax exemption is $11.4 million ($22.8 million for a married couple). But some states levy estate tax with a much lower exemption and some states may also have an inheritance tax in addition to (or in lieu of) an estate tax.

Establish domicile

If you make a permanent move to a new state and want to escape taxes in the state you came from, it’s important to establish legal domicile in the new location. The definition of legal domicile varies from state to state. In general, your domicile is your fixed and permanent home location and the place where you plan to return, even after periods of residing elsewhere.

Each state has its own rules regarding domicile. You don’t want to wind up in a worst-case scenario: Two states could claim you owe state income taxes if you established domicile in the new state but didn’t successfully terminate domicile in the old one. Additionally, if you die without clearly establishing domicile in just one state, both the old and new states may claim that your estate owes income taxes and any state estate tax.

How do you establish domicile in a new state? The more time that elapses after you change states and the more steps you take to establish domicile in the new state, the harder it will be for your old state to claim that you’re still domiciled there for tax purposes. Some ways to help lock in domicile in a new state are to:

  • Buy or lease a home in the new state and sell your home in the old state (or rent it out at market rates to an unrelated party),
  • Change your mailing address at the post office,
  • Change your address on passports, insurance policies, will or living trust documents, and other important documents,
  • Register to vote, get a driver’s license and register your vehicle in the new state, and
  • Open and use bank accounts in the new state and close accounts in the old one.

If an income tax return is required in the new state, file a resident return. File a nonresident return or no return (whichever is appropriate) in the old state. We can help with these returns.

Make an informed choice

Before deciding where you want to live in retirement, do some research and contact us. We can help you avoid unpleasant tax surprises.

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.

Your succession plan may benefit from a separation of business and real estate

Your succession plan

Like most businesses, yours probably has a variety of physical assets, such as production equipment, office furnishings and a plethora of technological devices. But the largest physical asset in your portfolio may be your real estate holdings — that is, the building and the land it sits on.

Under such circumstances, many business owners choose to separate ownership of the real estate from the company itself. A typical purpose of this strategy is to shield these assets from claims by creditors if the business ever files for bankruptcy (assuming the property isn’t pledged as loan collateral). In addition, the property is better protected against claims that may arise if a customer is injured on the property and sues the business.

But there’s another reason to consider separating your business interests from your real estate holdings: to benefit your succession plan.

Ownership transition

A common and generally effective way to separate the ownership of real estate from a company is to form a distinct entity, such as a limited liability company (LLC) or a limited liability partnership (LLP), to hold legal title to the property. Your business will then rent the property from the entity in a tenant-landlord relationship.

Using this strategy can help you transition ownership of your company to one or more chosen successors, or to reward employees for strong performance. By holding real estate in a separate entity, you can sell shares in the company to the successors or employees without transferring ownership of the real estate.

In addition, retaining title to the property will allow you to collect rent from the new owners. Doing so can be a valuable source of cash flow during retirement.

You could also realize estate planning benefits. When real estate is held in a separate legal entity, you can gift business interests to your heirs without giving up interest in the property.

Complex strategy

The details involved in separating the title to your real estate from your business can be complex. Our firm can help you determine whether this strategy would suit your company and succession plan, including a close examination of the potential tax benefits or risks.

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.

Hastily choosing an executor can lead to problems after your death

Choosing the right executor

Choosing the right executor — sometimes known as a “personal representative” — is critical to the smooth administration of an estate. Yet many people treat this decision as an afterthought. Given an executor’s many responsibilities and complex tasks, it pays to put some thought into the selection.

Job description

An executor’s duties may include:

  • Collecting, protecting and taking inventory of the estate’s assets,
  • Filing the estate’s tax returns and paying its taxes,
  • Handling creditors’ claims and the estate’s claims against others,
  • Making investment decisions,
  • Distributing property to beneficiaries, and
  • Liquidating assets if necessary.

You don’t necessarily have to choose a professional executor or someone with legal or financial expertise. Often, lay-people can handle the job, hiring professionals as needed (at the estate’s expense) to handle matters beyond their expertise.

Candidate considerations

Many people choose a family member or close friend for the job, but this can be a mistake for two reasons. First, a person who’s close to you may be too grief-stricken to function effectively. Second, if your executor stands to gain from the will, he or she may have a conflict of interest — real or perceived — which can lead to will contests or other disputes by disgruntled family members.

If either of these issues is a concern, consider choosing an independent outsider as executor. Some people appoint co-executors — one trusted friend who knows the family and understands its dynamics and one independent executor with business, financial or legal expertise.

Designate a backup

Regardless of whom you choose, be sure to designate at least one backup executor to serve in the event that your first choice dies or becomes incapacitated before it’s time to settle your estate — or turns down the job. Contact us for answers to your questions about choosing the right executor.

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.