Michael Callahan
Opening your first paycheck and being dismayed by the amount is a rite of passage for young workers. FICA taxes sure can take a big bite out of your earnings. It’s not much comfort to a teen with their first job, but the Social Security taxes that they pay now will earn them Social Security benefits down the road.
It’s not just your paycheck that’s taxed for Social Security, though. Social Security retirement, disability and survivors benefits are taxable for everyone but low-income Americans. Once you start receiving Social Security benefits, the IRS may impose the federal income tax on either 50 percent or 85 percent of your benefits. Understanding how your Social Security benefits are taxed (or will be taxed once you start receiving them) is an important part of maximizing your retirement money.
How You’re Taxed While Working
Social Security benefits are funded by a dedicated payroll tax
of 12.4 percent on your gross pay, up to the taxable minimum ($147,000 in 2022). These taxes are collected under the Federal Insurance Contributions Act, which was enacted in 1935 in conjunction with the Social Security Act. (FICA includes Medicare taxes as well as Social Security taxes.)
When you work for an employer, you split the bill and each pay 6.2 percent of your gross wages for Social Security taxes and 1.54 percent for Medicare. Employers are responsible for withholding, paying and reporting their employees’ payroll taxes. Self-employed individuals are responsible for the full 12.4 percent Social Security tax and 2.9 percent Medicare tax.
Paying Social Security taxes gets a little more complicated for people who earn both employer wages and self-employed income, so this is something to discuss carefully with your tax planner.
How Social Security Benefits are Taxed
People who are living off of their Social Security benefits and have few or no other sources of income are often able to avoid paying any income tax on their benefits. But many people will pay income tax on either 50 percent or 85 percent of their Social Security benefits.
The IRS evaluates your tax obligations based on your filing status and your “combined income.” For this purpose, the IRS considers your combined income to be your adjusted gross income, plus any nontaxable interest and half of your Social Security benefits.
You’ll pay no taxes on Social Security benefits if:
• You file individually and your combined income is below $25,000.
• You file jointly and you and your spouse have a combined income below $32,000.
You’ll pay income taxes on 50 percent of your Social Security benefits if:
• You file individually and your combined income is between $25,000 and $34,000.
• You file jointly and you and your spouse have a combined income between $32,000 and $44,000.
You’ll pay income taxes on 85 percent of your Social Security benefits if:
• You file individually and your combined income is more than $34,000.
• You file jointly and you and your spouse have a combined income above $44,000.
Note that these tax thresholds don’t rise year by year. They were created by 1983 and 1993 amendments to the Social Security Act and have remained at the same levels ever since. To pay income taxes on Social Security, you may either make quarterly tax payments or elect to have a flat rate of 7, 10, 12 or 22 percent withheld from your benefits.
Tax Planning for Social Security Benefits
Tax planning has to be part of the conversation when you talk with your financial advisor about Social Security benefits. Always talk to your tax planner before doing things like taking IRA distributions. Since raising your income means paying more taxes on your benefits, you could essentially create double taxation on those distributions. Explore all the scenarios for reducing your taxes on benefits before claiming Social Security. The financial planners at Sachetta, LLC advise clients on a range of tax issues, including Social Security and taxes. Don’t make any guesses when it comes to things like paying Social Security taxes as a self-employed individual, or tax planning around your Social Security benefits. We’re here to help. Contact us today.
Michael J Callahan, CPA, CFP®, MST, is a Certified Financial Planner™ practitioner, Certified Public Accountant, and holds a Master’s Degree in Taxation from Bentley University. Mike has been involved in personal financial planning, as well as both business and individual taxation for more than 15 years. Our ideas about money are formed by our life experiences. Over the years, Mike has seen those close to him make common money mistakes from not having enough life insurance, to not doing the proper estate planning. When he received an inheritance in college and started looking into how he could use it to achieve his goals, he realized that he could use those experiences to help others. He changed his major to Finance, and the rest is history.