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April 07, 2015 at 09:24 AM
The Social Security Act has established numerous programs which provide supplemental income for insured individuals and their families in the event of disability, when they retire, or at death. This supplemental income acts as a safety net — especially in old age — and keeps an estimated 43 percent of elderly American out of the poverty.
Congress passed the Social Security Act in 1935 and the retirement benefits program went into effect on January 1, 1937. The law has been amended many times since its original enactment.
With all these amendments, the taxation policy is complex for employers and individuals alike. Keep reading to find answers to 15 questions that are likely top of mind as your clients navigate tax season.
1. Are Social Security benefits subject to federal income taxation?
Social Security retirement, survivor, and disability benefits may be subject to federal income taxes in some cases. The person who has the legal right to receive the benefits must determine if the benefits are taxable. For example, if a parent and child both receive benefits, but the payment for the child is made to the parent’s account, the parent must use only the parent’s portion of the benefits in figuring if benefits are taxable. The portion of the benefits that belongs to the child must be added to the child’s other income to see if any of those benefits are taxable.
If the only income a person receives is Social Security benefits, the benefits generally are not taxable and he probably does not need to file a tax return. However, if a person has other income in addition to benefits, he may have to file a return (even if none of the benefits are taxable).
If the total of a person’s income plus half of his or her benefits is more than the base amount, some of the benefits are taxable. Included in the person’s total income is any tax-exempt interest income, excludable interest from United States savings bonds, and excludable income earned in a foreign country, United States possession, or Puerto Rico.
Voluntary federal income tax withholding is allowed on Social Security benefits. Recipients may submit a Form W-4V if they want federal income tax withheld from their benefits. Beneficiaries are able to choose withholding at 7 percent, 10 percent, 15 percent, or 25 percent of their total benefit payment.
2. What are the base amounts?
The base amount is as follows, depending upon a person’s filing status:[1]
- $32,000 for married couples filing jointly
- $0 for married couples filing separately and who lived together at any time during the year
- $25,000 for other taxpayers
If a person is married and files a joint return, the person and his spouse must combine their incomes and their Social Security benefits when figuring if any of their combined benefits are taxable. Even if the spouse did not receive any benefits, the person must add the spouse’s income to his when figuring if any of his benefits are taxable.
Example. Jim and Julie Smith are filing a joint return for 2013 and both received Social Security benefits during the year. Jim received net benefits of $6,600, while Julie received net benefits of $2,400. Jim also received a taxable pension of $10,000 and interest income of $500. Jim did not have any tax-exempt interest income. Jim and Julie’s Social Security benefits are not taxable for 2013 because the sum of their income ($10,500) and one-half of their benefits ($9,000 ÷ 2 = $4,500) is not more than their base amount ($32,000).
Any repayment of Social Security benefits a person made during the year must be subtracted from the gross benefits received. It does not matter whether the repayment was for a benefit the person received in that year or in an earlier year.
3. What portion of Social Security benefits are subject to income taxes?
The amount of benefits to be included in taxable income depends on the person’s total income plus half his or her Social Security benefits. The higher the total, the more benefits a person must include in taxable income. Depending upon a person’s income, he or she may be required to include either up to 50 percent or up to 85 percent of benefits in income.
50 Percent Taxable
If a person’s income plus half of his Social Security benefits is more than the following base amount for his filing status, up to 50 percent of his or her benefits will be included in his or her gross income:[1]
- $32,000 for married couples filing jointly
- $0 for married couples filing separately and who lived together at any time during the year
- $25,000 for all other taxpayers
85 Percent Taxable
If a person’s income plus half of his or her Social Security benefits is more than the following adjusted base amountfor his or her filing status, up to 85 percent of his or her benefits will be included in his or her gross income:[2]
- $44,000 for married couples filing jointly
- $0 for married couples filing separately and who lived together at any time during the year
- $34,000 for other taxpayers
If a person is married filing separately and lived with his or her spouse at any time during the year, up to 85 percent of his or her benefits will be included in his or her gross income.
4. Why is nontaxable interest income included in a taxpayer’s adjusted gross income?
Nontaxable interest income is included in income to limit opportunities for manipulation of tax liability on benefits. Individuals whose incomes consist of different mixes of taxable and nontaxable income are treated the same as individuals whose total income is taxable for federal income tax purposes.
5. Are workers’ compensation benefits included in the definition of Social Security benefits for tax purposes?
Yes, also included in the definition of Social Security benefits for tax purposes are workers’ compensation benefits, to the extent they cause a reduction in Social Security and Railroad Retirement tier I disability benefits. This is intended to assure that these social insurance benefits, which are paid in lieu of Social Security payments, are treated similarly for purposes of taxation.
6. How are overpayments and lump-sum retroactive benefits taxed?
Special rules are provided for dealing with overpayments and lump-sum retroactive benefit payments. Benefits paid to an individual in any taxable year are reduced by any overpayments repaid during the year. Taxpayers who received a lump-sum payment of retroactive benefits may treat the benefits as wholly payable for the year in which they receive them, or may elect to attribute the benefits to the tax years in which they would have fallen had they been paid timely. No benefits for months before 1984 are taxable, regardless of when they are paid.
Example 1. Ms. Jones is single. In 2012, she applied for Social Security disability benefits but was told she was ineligible to receive them. She appealed the decision and won her appeal. In 2013, she received a lump-sum payment of $6,000, which included $2,000 for 2012. She has two choices. She can use her 2013 income to figure the taxable part of the entire $6,000 payment, or she can use her 2012 income to figure the taxable part of the $2,000 received for 2012. In the latter case, for 2012 she would include only the $4,000 attributable to 2013.
Example 2. Assume that Mr. Jackson receives a $1,000 Social Security benefit in 2013, $400 of which is attributable to 2012. Assume also that the $1,000 benefit would increase Mr. Jackson’s 2013 gross income by $500 (i.e., by the full 50 percent), but that the $400 would have increased his 2012 gross income by only $150, and the remaining $600 would have increased his 2012 gross income by $300. He may limit the increase in 2013 gross income to only $450, the sum of the increases in gross income that would have occurred had the $400 been paid in 2012.
7. What reporting requirements must be met by the Social Security Administration?
The Commissioner of Social Security must file annual returns with the Secretary of the Treasury setting forth the amounts of benefits paid to each individual in each calendar year, together with the name and address of the individual. The Commissioner of Social Security must also furnish similar information to each beneficiary by January 31 of the year following the benefit payments. The statement will show the total amount of Social Security benefits paid to the beneficiary, the total amount of Social Security benefits repaid by the beneficiary to the Social Security Administration during the calendar year, and the total reductions in benefits to offset workers’ compensation benefits received by the beneficiary.
8. Are Social Security benefits subject to income tax withholding?
Voluntary federal income tax withholding on Social Security benefits is allowed. Recipients may submit a Form W-4V if they want federal income tax withheld from their benefits. Recipients may choose withholding at 7 percent, 10 percent, 15 percent, or 25 percent of their total benefit payment.
9. If a recipient of Social Security benefits elects Medical Insurance (Part B) under Medicare and the premiums are deducted from the individual’s benefits, is the whole benefit, before the deduction, a Social Security benefit?
Yes, the individual is treated as if he received the whole benefit and later paid separately for the Medical Insurance (Part B) coverage. Both the Commissioner of Social Security and the Railroad Retirement Board will include the entire amount as paid to the individual in the statements they furnish.
10. What are the Social Security and Medicare tax rates for employers and employees?
The tax rate is the same for both the employer and the employee. Every employer who employs one or more persons and every employee in covered employment is subject to the tax imposed under the Federal Insurance Contributions Act (FICA).
The tax consists of two taxes: the OASDI tax (the tax for old-age, survivors, and disability insurance) and the Hospital Insurance (HI) tax (for Medicare Part A).
For 2015, the maximum earnings base (the maximum amount of annual earnings subject to the tax) for the OASDI tax is $118,500. There is no maximum earnings base for the HI tax. All wages and self-employment income are subject to the HI tax.
For employees and employers, the rate of the OASDI tax is 6.20 percent, and the rate of the HI tax is 1.45 percent. Thus, the maximum OASDI tax for an employee in 2015 (with maximum earnings of $118,500) is $7,347. The maximum HI tax is unlimited because all wages are subject to the tax.
| OASDI TAX ON EMPLOYEES AND EMPLOYERS |
||||
| Year |
% Rate (OASDI) |
Max. Wage Base |
Max. Tax (each) |
Max. Tax (both) |
| 1986 |
5.70 |
$42,000 |
$2,394.00 |
$4,788.00 |
| 1987 |
5.70 |
43,800 |
2,496.60 |
4,993.20 |
| 1988 |
6.06 |
45,000 |
2,727.00 |
5,454.00 |
| 1989 |
6.06 |
48,000 |
2,908.80 |
5,817.60 |
| 1990 |
6.20 |
51,300 |
3,180.60 |
6,361.20 |
| 1991 |
6.20 |
53,400 |
3,310.80 |
6,621.60 |
| 1992 |
6.20 |
55,500 |
3,441.00 |
6,882.00 |
| 1993 |
6.20 |
57,600 |
3,571.20 |
7,142.40 |
| 1994 |
6.20 |
60,600 |
3,757.20 |
7,514.40 |
| 1995 |
6.20 |
61,200 |
3,794.40 |
7,588.80 |
| 1996 |
6.20 |
62,700 |
3,887.40 |
7,774.80 |
| 1997 |
6.20 |
65,400 |
4,054.80 |
8,109.60 |
| 1998 |
6.20 |
68,400 |
4,240.80 |
8,481.60 |
| 1999 |
6.20 |
72,600 |
4,501.20 |
9,002.40 |
| 2000 |
6.20 |
76,200 |
4,724.40 |
9,448.80 |
| 2001 |
6.20 |
80,400 |
4,984.80 |
9,969.60 |
| 2002 |
6.20 |
84,900 |
5,263.80 |
10,527.60 |
| 2003 |
6.20 |
87,000 |
5,394.00 |
10,788.00 |
| 2004 |
6.20 |
87,900 |
5,449.80 |
10,899.60 |
| 2005 |
6.20 |
90,000 |
5,580.00 |
11,160.00 |
| 2006 |
6.20 |
94,200 |
5,840.40 |
11,680.80 |
| 2007 |
6.20 |
97,500 |
6,045.00 |
12,090.00 |
| 2008 |
6.20 |
102,000 |
6,324.00 |
12,648.00 |
| 2009-2011 |
6.20 |
106,800 |
6,621.60 |
13,243.20 |
| 2012 |
6.20 |
110,100 |
6,826.20 |
13,652.40 |
| 2013 |
6.20 |
113,700 |
7,049.40 |
14,098.80 |
| 2014 |
6.20 |
117,000 |
7,254.00 |
14,508.00 |
| 2015 |
6.20 |
118,500 |
7,347.00 |
14,694.00 |
| Note: The 1.45 percent Medicare tax applies to all wages. |
||||
The OASDI maximum earnings base and maximum tax are subject to automatic adjustment in 2016, and after based on changes in wage levels.
Under the Patient Protection and Affordable Care Act of 2010, new Medicare taxes are imposed starting in 2013. Under the provisions of the new law most taxpayers will continue to pay the 1.45 percent Medicare tax, but single people earning more than $200,000 and married couples earning more than $250,000 will be taxed at an additional 0.9 percent (2.35 percent in total) on the excess over those base amounts. Self-employed persons will pay 3.8 percent on earnings over those thresholds.
Employers will collect the extra 0.9 percent on wages exceeding $200,000 just as they would withhold Medicare taxes and remit them to the IRS. However, companies won’t be responsible for determining whether a worker’s combined income with his or her spouse made them subject to the tax.
Instead, some employees will have to remit additional Medicare taxes when they file income tax returns, and some will get a tax credit for amounts overpaid. Married couples with combined incomes approaching $250,000 will have to keep tabs on both spouses’ pay to avoid an unexpected tax bill.
Beginning in 2013, a Medicare tax will, for the first time, be applied to investment income. A new 3.8 percent tax will be imposed on net investment income of single taxpayers with Adjusted Gross Income (AGI) above $200,000 and joint filers with AGI over $250,000.
Net investment income is interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property (other than property held in a trade or business). Net investment income is reduced by the deductions that are allocable to that income. However, the new tax won’t apply to income in tax-deferred retirement accounts such as 401(k) plans.
Not all earnings are subject to Social Security taxes. A person can be an employee but be exempt from the Social Security tax. An example is an individual hired by a federal agency on a temporary basis as an emergency firefighter to help fight forest fires. The individual performed the service for three months, twelve hours a day, and the federal agency supplied the necessary equipment and gave him directions on a daily basis. The Internal Revenue Service ruled that, although the individual was an employee under common-law rules, he was exempt from Social Security taxes, as the Internal Revenue Code exempts from the definition of employment those services performed for the United States by an individual serving on a temporary basis in case of fire or other emergencies.
