Social Security (SS) income is not taxable until a taxpayer’s AGI (without Social Security income) plus 50% of their Social Security income plus tax-exempt interest income, and plus certain other infrequently encountered additions exceeds a specific threshold. The threshold is $32,000 for married taxpayers filing jointly, zero for married taxpayers filing separately and $25,000 for all others. Once the threshold is exceeded, the Social Security income subject to tax varies from 50% to 85%. Few taxpayers understand this threshold for SS taxation and make no attempt to employ strategies to minimize the SS taxability or take advantage of the unused threshold amount. If a taxpayer’s only income for the year is from Social Security then there is no tax on the Social Security. However, if that is true and the taxpayer has other possible source(s) of income, the taxpayer can actually take in additional income without causing any of his SS income to become taxable. Take, for example, a 68-year-old single individual with an annual SS income of $18,000. The threshold for single individuals is $25,000, and subtracting ½ the SS income in this example from the $25,000 leaves a $16,000 difference. That is an additional $16,000 of income the taxpayer could have had that year without causing any of his SS benefits to become taxable. For 2011, a single individual age 65 or older gets a standard deduction of $7,250 and an exemption of $3,700. Thus in our example, if the taxpayer had an IRA and took a distribution from it of $16,000, he would have only been taxed on $5,050 ($16,000 – $7,250 – $3,700), and the tax would have been a minimal $505 because he is in the lowest possible tax bracket, 10%. If that same taxpayer had been saving his IRA for his beneficiaries to inherit, then he just saved them a lot of money, because they would be taxed on the IRA based on their tax rates which will no doubt be higher. They can inherit the bank account he put the distribution in without any tax (assuming the total value of his estate is under the estate tax exemption amount for his year of death). He also reduced his IRA value so when he reaches the 70-½ mandatory distribution age he will not have to take out as much, potentially again reducing his tax. If a taxpayer is 70-½ years of age or over, they are required to start taking required minimum distributions (RMD) from IRAs and most other retirement plans. The amount of the RMD can impact the taxation of the taxpayer’s Social Security benefits. For 2011, a taxpayer aged 70-½ and over can make a direct IRA to charity distribution which also counts toward the taxpayer’s RMD for the year. The distribution is not included in income (therefore does not impact the taxability of the Social Security) and the charitable contribution is not deductible, since the distribution from which the contribution was made is not includable in the income for the year. An added benefit is when a taxpayer has a substantial charitable contribution and he only marginally itemizes. Donations to charities are tax deductible only when a taxpayer itemizes deductions. By replacing the RMD income and charitable contribution with a direct IRA–to-charity rollover the taxpayer has the satisfaction of contributing to a favorite charity while at the same time being able to exclude the distribution from income and utilize the standard deduction to reduce his tax bite. Foreign government Social Security benefits received by U.S. Residents are taxed according to the treaty with that country. For example, per treaty provisions, SS benefits from our neighbor Canada are taxed in the same manner as U.S. Social Security benefits. Some U.S. States do not tax U.S Social Security benefits. However, states are not a party to the federal-level tax treaties and may treat the foreign Social Security payments differently. For example, although the state of California does not tax any amount of U.S. Social Security, it treats Canadian Social Security benefits as a fully taxable pension. If a taxpayer receives a retroactive Social Security payment during the current year that is related to a prior tax year, the entire payment must be included in the current year’s income. This may cause the SS benefits to be taxed at a higher rate than they would have been if they had been reported in the prior year. To adjust for this inequity, the IRS provides a special lump-sum calculation. Some or all of a taxpayer’s Social Security benefits may have to be repaid if the taxpayer has earned income above an annual threshold and the taxpayer is under the full retirement age. The full retirement age currently is 67 and the 2011 earnings threshold is $14,160. If you have additional questions related to the strategies suggested in this article and would like to see how they would impact your tax situation, please give this office a call.