Taxation

Tax on Social Security & Tier 1 Railroad Benefits

Many retirees depend on Social Security benefits or other government-sponsored retirement benefits as a primary source of retirement funds, using it to pay for everything from rent to groceries. It might come as a surprise to some retirees when 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. Knowing if and how your benefits may be taxed will help you 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, including monthly retirement, survivor, and disability benefits. It doesn't include Supplemental Security Income (SSI) payments, which aren't taxable
  • Tier 1 Railroad Retirement benefits. These are part of the benefits a railroad employee would've been entitled to under the Social Security system. These benefits 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 you can complete your income tax forms.

How Benefits Are Taxed

The federal tax code sets out how much of your Social Security and Tier 1 benefits, if any, are taxable. A three-level system based on your modified adjusted gross income (MAGI) is used.

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 a 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 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 received $10,000 of Social Security benefits in 2010. You also earned $12,000 from a part-time job, 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). None of your benefits are taxable because your MAGI plus 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 percent of your benefits in gross income. If your MAGI plus half of your benefits is more than the base amount, you have to report the lesser of:

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

High income taxpayers. Here you may have to report up to 85 percent of your benefits as gross income. If your MAGI plus half of your benefits go above an adjusted base amount, you have to report the lesser of:

  • 85 percent of the benefits received, or
  • The sum of: (1) 85 percent 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) $9,000, or $12,000 if you file jointly, for 2010

There are three adjusted 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

Also, 85 percent of your benefits may be taxable if you're married filing separately and you lived with your spouse during the tax year.

Get It Right

You don't want to pay taxes 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, and if you still have questions, be sure to talk to a professional tax preparer or a tax lawyer before you file.

Questions for Your Attorney

  • I get Social Security retirement benefits and my spouse gets Tier 1 benefits. Should we file jointly?
  • Should I take monthly payments of Tier 1 benefits or a lump sum payment of the benefits?
  • Can I work out a payment plan instead of paying the taxes on my Social Security benefits all at once?
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