Unfortunately, a certain amount of Social Security benefits are now being taxed. But it wasn't always this way. According to Taxation of Social Security Benefits at SocialSecurity.gov: "Under legislation enacted in 1983, the Social Security Trust Funds receive income based on Federal income taxation of benefits."
This legislation resulted in Social Security benefits being taxed up to 50%. That's the bad news for taxpayers. However, not everyone will be taxed: "The funds receive taxes on up to 50% of benefits from single taxpayers with incomes over $25,000 and from taxpayers filing jointly with incomes over $32,000." (For more, see: How Does My Spousal Social Security Benefit Work?)
Some Taxed, Some Not
These are pretty low thresholds and mean that many taxpayers will pay some taxes on their Social Security benefits, but some will not.
There was another piece of legislation in 1993 which extended taxation of benefits. This legislation increased the percentage of benefits subject to taxation from 50% all the way up to 85% for those above certain income amounts: "The legislation increased the limitation on the amount of benefits subject to taxation from 50% to 85% for single taxpayers with incomes over $34,000 and for taxpayers filing jointly with incomes over $44,000."
The first piece of legislation was designed to put money back into the Social Security Trust Funds while the second puts all additional tax income into Medicare's Hospital Insurance Trust Fund.
How to Calculate Taxes
There are two ways you can calculate the taxation of Social Security benefits. (For more, see: Social Security 'Start, Stop, Start' Strategy Explained.)
First, you could opt to print and fill out IRS Publication 915. This publication includes instructions and a worksheet so you can complete the math yourself, but it may take quite some time. Here's an example paragraph from the publication:
"Benefits not taxable. If you are filing Form 1040EZ, do not report any benefits on your tax return. If you are filing Form 1040 or Form 1040A, report your net benefits (the total amount from box 5 of all your Forms SSA-1099 and Forms RRB-1099) on Form 1040, line 20a, or Form 1040A, line 14a. Enter -0- on Form 1040, line 20b, or Form 1040A, line 14b. If you are married filing separately and you lived apart from your spouse for all of 2014, enter "D" to the right of the word "benefits" on Form 1040, line 20a, or Form 1040A, line 14a."
If this kind of language bores you or seems too complicated, you might want to calculate the taxation of your Social Security benefits in another way. However, manually filling out the forms yourself is likely the cheapest option.
You could opt to use tax preparation software, which will ask you questions and automatically calculate the tax liability of your Social Security benefits for you. This is the easiest solution, although you will have to depend on the reliability of the software to churn out an accurate number. Tax preparation software is relatively inexpensive and can usually be acquired for much less than $200.
Another solution is to sit down with a licensed tax preparer in your state. Licensed tax preparers encounter a plethora of tax situations presented by their clients and are typically well-versed in state and federal tax law. As an additional layer of protection, many licensed tax preparers use tax preparation software to assist them in their calculations. While you will probably pay more to have professional look over your documents, it can give you peace of mind and ensure a lot less frustration come tax time.
The Bottom Line
Whichever method you choose to calculate the taxation of your Social Security benefits—going the self-calculation route if you're comfortable doing it vs. spending a bit more money to have a professional look it over — make sure to remember to pay taxes on your benefits should you be required to do so. It's best to mark it on your calendar as a reminder. You'll be glad you did. (For more, see: 10 Steps to Tax Preparation.)