Some people’s Social Security retirement benefits are not included in taxable income and are therefore not taxed.  Why are they special?  Simply because their income, in this case their ‘provisional income’, is below a certain threshold.  For Single Taxpayers with provisional income of less than $25,000 and Married Taxpayers with provisional income below $32,000, benefits are effectively ‘not taxed’.  What is provisional income, you ask?  I will give you that recipe near the end of this article.

People with provisional income above the thresholds must include some of their benefits as taxable income.  The most that needs to be included under current law is 85%.  How do you calculate the amount that must be included?  The best way to explain this is with an example:

 

Married Couple with Provisional Income of $50,000 and

combined Social Security Retirement Benefits of $30,000

           Calculation A (uses Provisional Income)

                0% of the first $32,000                                                                       =$          0

                50% of the amount between $32,000and $44,000                      = $  6,000

                85% of the amount over $44,000                                                    = $  5,100

                                                                                               Total              = $11,100

           Calculation B (uses Social Security Benefit)

                85% of entire benefit                                                                         = $25,500

The LESSER of A or B is $11,100 = the amount that must be included in taxable income.

In this example, only $11,100 of the $30,000 would be included in the couple’s taxable income.  We can use the same numbers but change the scenario to a Single Taxpayer with the following results:

 

Single Taxpayer with Provisional Income of $50,000 and

a Social Security Retirement Benefit of $30,000

           Calculation A (uses Provisional Income)

                0% of the first $25,000 is taxable                                                    =$          0

                50% of the amount between $25,000 and $34,000                     = $  4,500

                85% of the amount over $34,000                                                    = $13,600

                                                                                               Total              = $18,100

           Calculation B (uses Social Security Benefit)

                85% of entire benefit                                                                         = $25,500

The LESSER of A or B is $18,100 = the amount that must be included in taxable income.

In this example, only $18,100 of the $30,000 would be included in the individual’s taxable income.

The recipe for Provisional Income:

All income that would normally appear on page 1 of your federal tax return (except social security benefits)

+

Any amounts excluded from your income under an Employer Adoption Assistance Program

+

Anything deducted as interest on an education loan or as a qualified tuition expense

+

Anything earned in a foreign country, a U.S. possession or Puerto Rico

+

One-half of your Social Security Retirement Benefits

+

All tax-exempt interest

 

Summary

The good news is that all of the tax programs on the market today do these calculations for you!  Reducing provisional income can double your savings in some situations.  Because this is a complex topic, be sure to discuss your specific situation with your financial planner and your tax advisor.  They may be able to find some tax-saving opportunities for you.