March 5, 2004  Email this  Print this
 License or reprint this articleTAX TIPS
Don't Overtax Social Security Benefits
by Kevin McCormally  Quite a firestorm erupted last week when Federal Reserve Board Chairman Alan Greenspan warned Congress that social security benefits might have to be cut in the future as the Baby Boom generation begins to retire. As Homer Simpson might say: D'oh! Greenspan has been saying pretty much the same thing for 20 years. Sooner or later (read later in an election year), lawmakers are going to have to face the fact that something has to be done about social security.
If you're getting benefits now, don't worry. Your check will not be reduced. The more pertinent question for you is the following:
Are my benefits taxable?
A. Yes
B. No
C. Maybe
The answer, of course, is C. Whether Uncle Sam wants a piece of your benefits depends on how much money you make. Whether your state demands a cut, too, depends on where you live.
The bottom line: You have to be careful to avoid paying too much tax on your benefits.
At the federal level, two-thirds of retirees can breathe easy: Their benefits remain tax-free. For the other 15 million Americans who get social security, however, part of the benefits are taxed. To figure out how much, you have to complete an 18-line worksheet in the tax instructions. (Or, if you use tax preparation software such as TaxCut -- which includes expert tips from Kiplinger's -- your computer will do the numbers crunching for you.)
The first step is to add up your "provisional income." That's basically your adjusted gross income (AGI is taxable income before subtracting exemptions and deductions) plus one-half of your benefits plus any tax-free interest from municipal bonds.
If that amount is less than $25,000 if you file as a single person or a head of household or if it is less than $32,000 if you file a joint return with your spouse, then your benefits are tax-free.
If your provisional income falls between $25,000 and $34,000 on a single or head of household return or between $32,000 and $44,000 on a joint return, up to half of your benefits can be taxed. If it's more than the top level of the range that applies to you, up to 85% of your benefits can be -- and likely will be -- taxed. Again, use the worksheet -- or tax software -- to pinpoint the taxable portion.
A recent study found that things are better for retirees at the state level but still can be confusing. Currently, 26 of the 41 states that have broad-based income taxes do not tax social security benefits at all. Fifteen states have their own rules. If you live in one of them, be sure to understand those rules so you don't report too much of your benefits as taxable income.
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