Trim the Tax on Your Social Security Benefits

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.
● If your CI is under $25,000 (single) or $32,000 (joint) and likely to stay there, you don’t need to do anything. You won’t owe any tax on your Social Security benefits.
● If your CI is now or is expected to be above $25,000 (single) or $32,000 (joint), you may be able to profit from tax planning. Our office can let you know if there are practical strategies you can use. By lowering your CI, you might be able to reduce the tax on your Social Security benefits.
● If you expect your CI to be far above the $34,000 (single) or $44,000 (joint) thresholds, there might be nothing you can do in
this area. Our office can help you determine whether you are in this category. If so, you may have to resign yourself to having 85% of your benefits taxed. 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 impact can go beyond the tax on your Social Security benefits. Our office can help you evaluate possible strategies for reducing this tax.