Dear Clients and Friends:

A frequently asked question is, "How are Social Security benefits taxed?" The answer is that it depends on your other income; in the worst-case scenario, 85% of your benefits would be taxed. This does not mean that you pay 85% of your benefits back to the government in taxes‹but merely, that you would include 85% of your benefits in your income subject to your regular tax rates.

To determine how much of your benefits are taxable, you must first determine your other income, including, for this purpose, tax-exempt interest. Add to that the income of your spouse, if you file jointly. To this add half of the Social Security benefits you and your spouse receive during the year. The figure you arrive at is your total income plus half of your benefits. Now apply the following rules:

1. If your income plus half of your benefits is not above $32,000 ($25,000 for single taxpayers), none of your benefits are taxed.

2. If your income plus half of your benefits exceeds $32,000 but is below $44,000, you will be taxed on one half of the excess over $32,000 or one half of the benefits, whichever is lower.

Example (1): Sam and Denise have $20,000 in taxable dividends, $2,400 of tax-exempt interest, and combined Social Security benefits of $21,000. Thus, their income plus half their benefits is $32,900 ($20,000 plus $2,400 plus 1/2 of $21,000). They must include $450 of their benefits in gross income (1/2 ($32,900 - $32,000)). (If their combined Social Security benefits were $5,000, and their income plus one half of their benefits were $40,000, they would include $2,500 of the benefits in income: 1/2 ($40,000 - $32,000) equals $4,000, but 1/2 of the $5,000 of benefits ($2,500) is lower, and the lower figure is used.)

For single taxpayers substitute the following for the above:

3. If your income plus one half of your benefits exceeds $25,000 but is below $34,000, you will be taxed on (1) one half of the excess over $25,000 or (2) one half of the benefits, whichever is lower. Example (1A): Sam has $20,000 in taxable dividends, $2,400 of tax-exempt interest, and Social Security benefits of $9,000. Thus, his income plus half his benefits is $26,900 ($20,000 plus $2,400 plus 1/2 of $9,000). He must include $950 of his benefits in gross income (1/2 ($26,900 - $25,000)). (If his Social Security benefits were $3,000, and his income plus half his benefits were $30,000, he would include $1,500 of the benefits in income: 1/2 ($30,000 - $25,000) equals $2,500, but 1/2 the $3,000 of benefits ($1,500) is lower, and the lower figure is used.)

4. If your income plus one half of your benefits exceeds $44,000 ($34,000 for single taxpayers), the computation in many cases becomes far more complexed. Generally, however, unless your income plus one half of your benefits is fairly close to $44,000 ($34,000 for single taxpayers), 85% of your Social Security benefits will be taxed.

Caution: Since higher income results in more Social Security benefits being taxed, an unplanned increase in income can have a double tax cost. You will be taxed on the additional income and will also pay tax on more of your Social Security benefits. Additionally, you may get pushed into a higher marginal tax bracket. This situation might arise, for example, when you receive a large distribution from a retirement plan during the year.

Careful planning can avoid the stiff tax bill resulting from the IRA distribution. The withdrawal could be spread out over more than one year. Another way to save in taxes is to liquidate assets other than an IRA account, such as stock showing only a small gain or stock whose gain can be offset by a capital loss on other shares. If you should need a large amount of cash for a specific purpose, please contact me before withdrawing money from a retirement savings account so that the best method of raising the cash can be determined.

If you would like me to run some specific numbers for you or if you'd like to discuss this matter further, please call (315)363-3338.

Very truly yours,

G. William Hatfield
Certified Public Accountant
Certified Financial Planner