While politicians consider changes in Social Security, millions of people continue to receive benefits. Are those benefits taxable? That's determined by a complicated formula, and if you know how it works, you may be able to reduce or eliminate the tax you owe on your social security benefits.

To begin the calculation, determine your combined income (CI) for this purpose. To find your CI, start with half of your Social Security benefits, then add that number to all of your other income, including tax exempt income and other exclusions from income.

Once you've determined your CI, compare it with certain base amounts. The first base amounts are $25,000 for single taxpayers and $32,000 for married couples filing jointly.

Numbers Crunch

If your CI is over the relevant base amount, you'll owe tax on some of your Social Security benefits.

Example: Kim Phillips receives $14,000 in Social Security benefits in 2011.She also has $20,000 in other income. Thus, Kim's CI is $27,000: $7,000 (half of $14,000) plus $20,000.
Kim is single so her base amount is $25,000. With $27,000 of CI, Kim is $2,000 over the threshold.

The next step is to compare the excess ($2,000) with half of Kim's Social Security benefits ($7,000). The smaller of the two numbers -- $2,000, in this example -- will be added to her taxable income. Here, Kim receives $14,000 in benefits and owes income tax on $2,000 of those benefits.

If your CI is high enough, you will encounter a second set of base amounts: $34,000 for singles and $44,000 for joint returns. Over those thresholds, up to 85% of your Social Security benefits may be added to your taxable income. Note that this doesn't mean you would owe 85% tax on your Social Security benefits. If you receive $20,000 in benefits and you owe the maximum tax, you'd add $17,000 (85% of $20,000) to your taxable income. Assuming a 28% tax rate, you would owe $4,760 in tax on the $17,000. That's an effective tax rate of less than 24% on your Social Security benefits.

Tax Tactics

Once you understand the process, you can see whether tax planning makes sense.

Possible tactics for reducing your CI include taking losses to offset capital gains and investing in growth stocks rather than dividend paying stocks. Tapping an immediate annuity for income or taking out a reverse mortgage also may provide cash flow that won't count towards your CI. Make such decisions carefully because their income can go beyond the tax on your Social Security benefits. Toscano & Ardito P.C. can help you evaluate possible strategies for reducing this tax.

Please don't hesitate to contact us if you want more details or would like to schedule an appointment to discuss further. We look forward to hearing from you.

---