It seems like such good news — Social Security benefits are going up 8.7% next year, thanks to inflation. But for a lot of people, their tax bill could go up, too.
That’s because tax rates on Social Security benefits are not changing with inflation.
Taxing Social Security benefits began in 1984 as part of a sweeping reform of the system. It was intended to tax the wealthiest recipients.
But over the years, as the annual cost of living increased, more and more people qualified for the tax. With next year’s benefits going up at their steepest levels in 42 years, more people will be taxed.
“This is very much a middle-class problem. You are hitting the middle earner, even people with modest incomes,” said Mary Johnson, Social Security and Medicare policy analyst at the nonpartisan Senior Citizens League. “It’s really going to be a very negative surprise.”
The average retired worker’s monthly benefit will go in January from $1,681 to $1,827. An older couple who both get benefits would see their monthly amounts go from $2,734 to $2,972.
About 6 million Californians receive benefits with no state tax.
Federal benefits taxation is based on a complex formula involving what’s called “combined income.” If that income is between $25,000 and $34,000 for an individual, they could pay tax on up to 50% of their benefits. If the income is higher, up to 85% of their benefits can be taxable.
Those filing a joint return could pay tax on up to 50% of benefits if their combined income is between $32,000 and $44,000. If the income tops $44,000, the benefits can be taxed at up to an 85% rate.
“Lower income beneficiaries may find themselves owing federal taxes due to the increase in Social Security benefits,” since their total “combined income” may have increased, said Jodie Rolih, a certified public accountant and senior tax manager at Sensiba San Filippo in Pleasanton, California.
The Congressional Budget Office estimated that nearly half of Social Security beneficiaries, or more than 25 million people, were affected by the income taxation of Social Security benefits in 2014. That’s nearly twice as many as 1998.
The percentage is thought to have stabilized somewhat because of higher standard deductions since then. Next year, the standard deduction will again increase because of inflation.
But, CBO warned, “That share (of beneficiaries paying the tax) is expected to grow over time because the income thresholds used to determine the taxable share of benefits are not indexed for inflation or wage growth.”
The antidote for the higher taxes would seem simple.
“The taxable maximum wage should also rise as … wages increase,” said Garrett Watson, senior policy analyst at the Tax Foundation in Washington.
“In that way, there remains some connection between benefits growth and contributions over time,” he said.
There appears to be little appetite to change the law.
“There’s been a reluctance to change individual pieces without a broader look at Social Security,” said David Certner, AARP legislative counsel. The tax was intended to help boost Social Security’s finances, which are expected to face more trouble in the years ahead.
One plan has come from the Republican Study Committee, the House’s conservative policy arm. It has proposed phasing out the benefit tax beginning in 2051, saying “Retirees earning Social Security benefits should not be punished for staying active.”
