Editor's Note: Associate Editor Karen DeMasters writes the Social Security beat. Please send ideas to her at [email protected].

Many near-retirees may not realize part of their Social Security benefits could be subject to income tax.

"I think more people are aware of other regulations than the fact that their Social Security Benefits may be taxed," says Larry Rosenthal, CFP, president of Rosenthal Wealth Management Group in northern Virginia.

"It is definitely something a financial advisor should point out to their clients," he adds.

Rosenthal helps his clients determine the amount of Social Security that may be taxable during retirement. "There are strategies for minimizing the tax bite if you prepare ahead of time," he says.

"I had a caller on my radio show, 'Making Money Sense,' just the other day who was questioning whether he had to pay income tax on his benefits," he says.

For most of one's working life Social Security is a tax so it might seem unusual to then pay a tax on the benefits that are eventaully received. But, in fact, no income tax has been paid on the Social Security money paid in over the years by the employee or the employer.

Whether a recipient pays taxes on Social Security benefits depends on how much additional income the person receives, above and beyond their benefit. Taxes are never applied on all of the Social Security benefit no matter how much a person earns; the maximum amount ever subject to income tax is 85 percent of the benefit.

Whether taxes must be paid depends on the person's combined income, which is the total of any salary or wages earned, pension benefits, investment income, tax-exempt interest and half of the Social Security benefit.

If combined income for a single person is between $25,000 and $34,000, up to 50 percent of the Social Security benefit is subject to tax. If the amount is more than $34,000, up to 85 percent of the benefit is taxable.

For a married couple filing jointly, the combined income limit is $32,000 to $44,000 for up to 50 percent of the benefit to be taxable and above $44,000 for up to 85 percent to be taxable.

Married couples filing separately will likely have to pay income tax on some of their benefit because there is no minimum income amount, says the IRS.

The percentage of the Social Security benefit on which income tax is applied is based on a sliding scale depending on how much outside income the person has. If a person relies solely on Social Security, no income tax will be applied.

Rosenthal notes that one way to reduce combined income is to make some adjustments prior to taking Social Security.

"For instance, if you plan to convert a traditional IRA to a Roth IRA, it may be wise to do so before collecting Social Security. The dollars you convert to a Roth become taxable income and could subject your Social Security benefits to higher taxation if you make the conversion after you start receiving benefits," he says.

Also the more a person can limit using investment income, the lower the combined income will be.

Income taxes could still be applied to other income besides Social Security benefits, depending on deductions and exemptions.

Another seeming contradiction is that Social Security taxes are still taken from any earnings and the employer continues to contribute the share for the employee even if the employee is collecting benefits while working, the Social Security Administration notes. The self-employed also must also continue contributing to Social Security even if they are collecting benefits.

Many state and local governments also collect income tax on Social Security benefits particularly in the Midwest, according to the IRS, and the rules vary by jurisdiction. Contact information for state agencies can be obtained at http://tax.sh/zOcthG, a free site through TurboTax, says the AARP.

A person can elect to have income tax withheld from Social Security benefits by contacting the IRS and filing the tax withholding form. Withholdings can be made of 7 percent, 10 percent, 15 percent or 25 percent.

People living in some foreign countries do not pay taxes on Social Security benefits or are subject to low rates because of tax treaties the United States has with the countries, AARP says.

 

-Karen DeMasters