Tax on Social Security & Tier 1 Railroad Benefits Text Size:

Are you retired, or thinking about retiring soon? If so, you're probably depending on government-sponsored retirement benefits as a source of income, just like millions of other retired American workers. Specifically, many retirees depend on Social Security benefits as a primary source of retirement funds, using it to pay for everything from rent to groceries.

While many of us have a general idea of what these retirement benefits are, it might come as a surprise to some retirees that they have to pay state and/or federal income taxes on the benefits they receive. Obviously, paying taxes on your retirement benefits reduces the amount of money you have to live on. Know if and how your benefits are taxed so that you can plan your retirement budget.

What Might be Taxed?

You have to pay income tax on two main types of government-sponsored retirement benefits:

• Social Security benefits, which includes things like monthly retirement, survivor, and disability benefits. They don't include Supplemental Security Income (SSI) payments, which aren't taxable
• Tier 1 Railroad Retirement benefits, which are part of the benefits that a railroad employee or beneficiary would've been entitled to receive under the Social Security system. They are commonly called the "Social Security Equivalent Benefit (SSEB) portion of Tier 1 benefits"

If you receive these benefits, you'll get a Form SSA-1099 "Social Security Benefit Statement," or a Form RRB-1099 "Payments by the Railroad Retirement Board." These forms tell you exactly how much money you received in benefits so that you can complete your income tax forms.

How It's Taxed?

A section of the federal tax code sets out how much of your Social Security and Tier 1 benefits, if any, are included in your gross income and subject to taxation. The tax code uses a three-level system that's based upon your modified adjusted gross income (MAGI).

What's your MAGI? Your adjusted gross income (AGI) is all of your income, such as wages, salary, and interest you get from bank accounts, minus certain deductions, like contributions you make to an retirement account. Your MAGI is your AGI:

• Minus various other deductions, like student loan interest and some tuition expenses
• Plus any foreign earned income exclusion, which might apply if you live in and earn income in another country, and tax exempt interest, which usually is interest you get on state or local government bonds

The Three Levels

Low Income Taxpayers. If your MAGI plus one-half of your benefits are below a certain base amount, you don't have to report any of your Social Security or Tier 1 benefits. For married taxpayers filing jointly, the base amount is $32,000. For married couples who live together and file separately, the base amount is $0. For all other taxpayers it is $25,000.

For example, you're 67 years-old and get $10,000 of Social Security benefits in 2008. You also earn $12,000 from a part-time, and you have $3,000 of taxable interest and $2,500 of tax-exempt interest. Here, your MAGI is $17,500 ($12,000 + $3,000 + $2,500). You don't have to report any of your benefits as income because your MAGI plus one-half of your Social Security benefits ($22,500) is less than $25,000.

Middle Income Taxpayers. If you're in this level, you may have to include up to 50% of your benefits in gross income. If your MAGI plus one-half of your benefits is more than the base amount, you have to report the lesser of:

• 50% of the benefits you received, or
• 50% of the excess of MAGI plus 50% of Social Security benefits over the base amount

For example, you and your wife are both 68, and file jointly. You each receive $15,000 of Social Security benefits. You earn $16,000 from a part-time job, and you have $6,000 of taxable interest. On your joint return, you report $2,500 of benefits in gross income, because:

• 50% of the excess of MAGI plus 50% of benefits over the base amount, or ($16,000 + $6,000 + ($30,000 x 50%)) - $32,000 = $5,000 x 50% = $2,500, is less than
• 50% of your benefits, or $30,000 x 50% = $15,000

High Income Taxpayers. If you're in this level, you may have to report as much as 85% of your benefits as gross income. If your MAGI plus one-half of your benefits go above an elevated base amount, you have to report the lesser of:

• 85% of the benefits received, or
• The sum of: (1) 85% x (MAGI + one-half of your benefits) minus the elevated base amount, plus (2) the lesser of (a) the amounts calculated by a "middle income taxpayer" or (b) $4,500 ($6,000 if you file jointly)

There are three different elevated base amounts:

• $44,000 for married taxpayers filing jointly
• $0 for married couples who live together but file separately
• $34,000 for all other taxpayers

For example, you and your husband file jointly. Combined, you earn $55,000 from part-time jobs, and you have $8,000 of taxable interest and $24,000 of benefits. Here, you have to include $20,400 of benefits as gross income because:

• 85% of your benefits (85% x $24,000) is less than
• The alternate computation: 85% x ($58,000 + (50% x $24,000) - $44,000 = $26,000) + the lesser of the amounts for a "middle income taxpayer" or $6,000

Get Help

Obviously, you don't want to pay taxes that you're not required to pay, and you don't want to risk having to pay a penalty for not paying taxes you owe. If you receive Social Security or Tier 1 benefits, look carefully at the IRS instructions on reporting your benefits as income. After doing so, if you still have questions, be sure to talk to your tax lawyer before filing your return.

Questions for Your Attorney

• I'm married and receive Social Security retirement benefits. My wife receives Tier 1 benefits. Should we file jointly or separately?
• I'm getting ready to retire in a few months. My employer has asked if I want to set up monthly payments of Tier 1 benefits, or if I want a lump sum payment. Which should I choose?
• I had to pay taxes on my Social Security benefits last year, and it hurt my budget to have to pay the tax all at once. Is there any way that I can avoid having to pay the taxes all at once?

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