Are we double-taxed on Social Security benefits?
Updated: May 18
Q. Are we Bamboozled when it comes to Social Security taxation? Paychecks are net amounts after various deductions, one of which is for Social Security. Income taxes are based on the gross earnings before Social Security deductions, therefore the money that was deducted for Social Security is being taxed. One could say Social Security contributions are after-tax money. Additionally, many retirees are taxed on 85 percent of their Social Security. Looks like double taxation to me. What do you think?
— Tax tired
A. It’s a smart observation. Here’s the history.
Prior to 1984 Social Security benefits were explicitly excluded from federal income taxation.
This changed with the passage of the 1983 Amendments to the Social Security Act, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.
So beginning in 1984, a portion of Social Security benefits have been subject to federal income tax.
There are currently three levels of taxation of Social Security benefits, Kiely said.
“The first level is zero percent of your benefit is taxed. The next level is 50 percent of your benefit is taxed,” Kiely said. “And if a single person has a combined income exceeding $34,000 or $44,000 if married filing jointly, 85 percent of your Social Security benefit will be taxed.”
So, you paid for your Social Security benefit with after-tax dollars over your entire working career, and now you have to pay tax on your benefits so it sure looks like double taxation, Kiely said.
But, let’s take a closer look.
Your Social Security benefit actually consists of three parts, Kiely said. The first part is your after-tax contributions. The second part of your benefit is the contributions your employer paid into the system over the years. Your employer’s contributions are the same amount as you paid in. The third part is all the untaxed earnings on you and your employer’s contributions over the years.
“Your and your employer’s contributions are not actually invested in any investment vehicle,” he said. “Your contributions are added to the general fund at the U.S. Treasury and the Social Security Administration gets an IOU from the Treasury Department.”
If you retire on Social Security and live as long as the actuaries say you should live, Kiely said, you will have collected far more in Social Security benefits than you and your employer ever paid into the system.
“We could argue that paying tax on 85 percent is too much,” Kiely said. “But it is what it is.”
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Karin Price Mueller writes the Bamboozled column for NJ Advance Media and is the founder of NJMoneyHelp.com. Follow NJMoneyHelp on Twitter @NJMoneyHelp. Find NJMoneyHelp on Facebook. Sign up for NJMoneyHelp.com’s weekly e-newsletter.