Tier 1: If your provisional income (PI) is between $32,000 and $44,000 ($25,000 and $34,000 for unmarried filers), you must pay tax on the lesser of one-half of your benefits or one-half of the amount by which your PI exceeds $32,000 ($25,000 for unmarried filers).
Tier 2: If your PI is above $44,000 ($34,000 for unmarried filers), you must include in your taxable income 85 percent of the amount by which your PI exceeds $44,000 ($34,000 for unmarried filers), plus the lesser of (a) the amount determined under the first tier or (b) $6,000 ($4,500 for unmarried filers).
Under no circumstances can the taxable amount exceed 85 percent of the benefits received. (Note: There are special rules for married taxpayers filing separate returns.)
Sound complicated? It is.
Example: To simplify, let’s say you and your spouse receive a taxable pension of $20,000, taxable interest of $14,000, tax-exempt interest of $6,000 and Social Security benefits of $16,000. Based on those amounts, your PI is $48,000 ($20,000 plus $14,000 plus $6,000 plus $8,000).
Since your PI is more than the $44,000 level, you’re taxed on $9,400 of your Social Security benefits: $6,000 from the first tier (the lesser of $8,000 or $6,000) plus $3,400 from the second tier (85 percent of $4,000).
Tip: The IRS has prepared a work sheet for you to use in Pub. 915 (Social Security Benefits and Equivalent Railroad Retirement Benefits). Find it at www.irs.gov/pub/irs-pdf/p915.pdf or call (800) 829-3676 for a copy.