Taxability of SS and net tax rate- add'l info

[kathyc2]

I had commented on a post earlier this week that a person receiving SS benefits can run into a net tax of 27.75% taking into account that the additional income will make more of SS taxable.

This is true for people in the 15% marginal rate. I was thinking that for someone to be in a higher than 15% marginal rate, they would already be at the 85% max SS taxability. This turns out to not be true.

Example: single person age 65 or older, SS benefits 22K and pension/IRA of 35K. They would have 14,700 of SS benefits taxable, and after std deduction and personal exemption they would have taxable income of 37,800 which is just a tad over where 25% rate starts. Total tax is 5,221.

Now if the pension/IRA income is 36K, taxable SS is 15,550 (850 more), taxable income is 39,650 and tax is 5,684. The 1K additional income results in $463 additional tax, or a 46.25% rate. This is verified by 25% + 21.25% (25% x .85).

This net rate would hold true until pension/IRA income is over 40K. At that point the 85% max taxability takes effect and additional income would result in the regular marginal rate of 25%.

For reference 1M in IRA's would have a 36.5K RMD at age 70.5.

The numbers are crazy, but something people projecting tax for clients in retirement years should be aware of. Something else to keep in mind is that is future years this will become more common due the fact that the amounts used to determine SS taxability have never been indexed for inflation.

[Rapid Robert]

The numbers are crazy Something else to keep in mind is that is future years this will become more common due the fact that the amounts used to determine SS taxability have never been indexed for inflation.

A single person with nothing but wage income can experience a tax rate of 1,200%, if their taxable income goes up by one dollar from $42,049 to $42,050. Talk about a bad deal!! And while the SS base amount for taxablility is not indexed for inflation, the tax brackets which determine the tax rate on that taxable income are indexed.

[Roland Slugg]

A single person with nothing but wage income can experience a tax rate of 1,200%, if their taxable income goes up by one dollar from $42,049 to $42,050.

Why narrow it down to a single person? And why narrow it down to wage income? And why narrow it down to that particular income level?

The phenomenon you describe can happen to anyone who uses the tax tables to figure his tax. Since the tax tables are in $50 increments (except at the very lowest levels), a $1 increase in taxable income can cost a taxpayer as much as $14 if it bumps him into the next line on the tables. Of course after that the next $49 are tax-free.

[kathyc2]

And while the SS base amount for taxablility is not indexed for inflation, the tax brackets which determine the tax rate on that taxable income are indexed.

True, but I was speaking more of as times goes on more and more people will have SS benefits taxed. 25K in 1984 is roughly 60K in today's dollars. I did a sample of my clients receiving SS and for 30% none is taxable, 40% some is taxable, and 30% 85% is taxable.

[Rapid Robert]

"Why narrow it down to a single person? And why narrow it down to wage income? And why narrow it down to that particular income level?"

That was kind of my point: why narrow it down to Social Security income, and a particular income level?

Other things have also not been indexed for inflation, such as the $400 net-earnings threshold for Self Employment tax. Politicians know full well what they are doing when they don't index certain things for inflation. For example, take the Net Investment Income tax, one of our newest: the thresholds ARE indexed for inflation for trusts/estates filing Form 1041, but not for Form 1040 filers. Why? (rhetorical question)

The fact is, so many "levers" have been built into our tax system on purpose, which is why the vile ones in Washington are never going to "simplify" our taxes despite their fake promises to the contrary. Not only the rates, but the items that are included in taxable income are tweaked, it is a way for politicians to say they have not changed the tax rate, while really changing the tax rate. When the AMT exemption phase-out thresholds were permanently adjusted for inflation a handful of years ago, that was a tax cut for the wealthy, but no one had to acknowledge it as such.

One way to fix the Soc. Security taxation "problem" would be to not index SS benefits for inflation - voila, no more tax rate creep!

[Rapid Robert]

Here is a really good discussion of this topic, with what I assume are reliable statistics to compare with what Kathyc2 sees in her own small sample.

https://www.ssa.gov/policy/docs/issu...ip2015-02.html

Did you know that exempting some SS benefits from taxation is designed to avoid double taxation? Or that the income taxes from SS benefits are directed toward SS and Medicare funding?

Or, "Eventually, the taxation of Social Security benefits will be roughly equivalent to the current-law taxation of pensions and annuities—which, according to the legislative history of the 1983 amendments, was Congress' intent when it set the threshold for taxation of benefits in nominal dollars."

[kathyc2]

That was kind of my point: why narrow it down to Social Security income, and a particular income level?

Because it came from a previous post where someone said clients should not convert to Roth pre SS benefits "unless he has an irrational desire to pay taxes needlessly early". I was pointing out that sometimes it makes complete sense. If someone is an a 15% bracket and not yet drawing SS they could convert 1K IRA to Roth for $150. If they are in the spot after benefits start where some but not the 85% of benefits are taxable, the tax effect will likely be 27.25%. A good investment should double every 10 years. In 20 years the 1K could be 4K, and a net rate of 27.25% would be $1,090. So, is paying more than 7 times the $150 in 20 years a good deal? If you were to invest the $150 for 20 years you would need a return of 11% to equal the 1,090.

It seems like we have been so conditioned to want to delay tax to a later time that we lose common sense. I myself was a little surprised that there is a spot where the effect can be over 45%.