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Slash retiree taxes on Social Security benefits

by on
in Small Business Tax,Small Business Tax Deduction Strategies

Don’t expect the taxman to go easy on you in retirement. When you start collecting Social Security retirement benefits, up to 85% of the benefits may be taxable.

Strategy: Be proactive about taxation of Social Security benefits. Depending on your situation, you can use one or more of the four strategies below to reduce or eliminate tax liability.

There is a common denominator. Each of the strategies is aimed at limiting your “provisional income” (PI) for Social Security purposes.

How it works: PI is an awkward tally of adjusted gross income (AGI); tax-exempt interest income; and one-half of the Social Security retirement benefits received. For example, if someone’s AGI for 2010 is $100,000; municipal bond income is $5,000; and Social Security benefits are $20,000, the PI is $115,000. What often confuses taxpayers is the inclusion of interest income that is otherwise tax-exempt in the PI computation.

The higher the PI, the greater the tax bite on Social Security benefits. Conversely, cutting down PI enables you to pay less tax—or even no tax—on the benefits. The tax law uses a three-tiered threshold:

  1. If the PI for joint filers is below $32,000 ($25,000 for single filers), there is no tax on Social Security benefits.
  2. If the PI is between $32,000 and $44,000 ($25,000 and $34,000 for single filers), up to half of the Social Security benefits are taxed.
  3. If the PI exceeds $44,000 ($34,000 for single filers), up to 85% of the Social Security benefits are taxed.

4 ways to lower the tax bill

The trick for reducing the tax on Social Security benefits is to knock down the PI below the next threshold. Here are four ideas:

1. Cash in on stock market losers. Are you currently holding paper losses on securities? The capital losses triggered before the end of the year can offset capital gains plus up to $3,000 of ordinary income. This may be enough to pull down your PI to a significantly lower level.

2. Borrow money for living expenses. Alternatively, you can support your retirement in your 60s by borrowing against your home, your life insurance or your securities portfolio. None of these maneuvers will produce taxable income, so your AGI won’t increase.

3. Defer taxable income to next year. For example, if you plan on investing in CDs or Treasury bills, make sure the investments won’t mature until 2011 or later. For instance, you can buy six-month T-bills after June 30, and the interest on the CDs won’t have to be recognized until next year.

4. Double up on IRA liquidations. If you need to tap an IRA for living expenses, you might take a double distribution in 2010. Next year, if you aren’t required to take withdrawals, you could live off of the proceeds without taking taxable funds from your IRA.

Tip: This last technique may give you one year on and one year off from taxation of Social Security benefits.

What's the 'normal' retirement age?

The age for receiving full Social Security retirement benefits depends on your year of birth.

For a person born in:

Normal retirement age is:

1937 or earlier

65 years

1938

65 years, 2 months

1939

65 years, 4 months

1940

65 years, 6 months

1941

65 years, 8 months

1942

65 years, 10 months

1943-1954

66 years

1955

66 years, 2 months

1956

66 years, 4 months

1957

66 years, 6 months

1958

66 years, 8 months

1959

66 years, 10 months

1960 and later

67 years

 Source: Social Security Administration

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