Some of your clients might be under the impression that Social Security benefits aren’t taxable – and they didn’t used to be. But everything changed with the passage of the 1983 Social Security Act amendments, and beginning in 1984, a portion of Social Security benefits were subject to federal income taxes.
According to Jane DeLashmutt O’Mara, portfolio manager at FBB Capital Partners, if an individual has other substantial income from wages, self-employment, interest, dividends or other taxable income, she will probably have to pay federal taxes on their Social Security benefits – up to 85 percent of the total benefit. The more she makes, the more taxes she will pay on her benefits.
In addition to the federal tax, 13 states tax Social Security benefits – Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont and West Virginia.
Unfortunately, there’s no real way for clients to avoid taxation of their Social Security income – but delaying their claims can help minimize their overall tax hit.
“If you don’t have a need for Social Security income at the time, it may make sense to defer your benefit until a later time,” DeLashmutt O’Mara notes. “Delaying your Social Security income could potentially increase your benefit, while lowering your tax burden.”
According to DeLashmutt O’Mara, the IRS uses a calculation to arrive at the tax due on Social Security benefits: The sum of the claimant’s adjusted gross income, plus non-taxable interest (e.g., municipal bonds), plus one-half of his or her Social Security income determines the claimant’s ‘combined income.’