Tax Tip: How Social Security and Railroad Retirement Is Taxed

Editor's Note: This article is part of our 2013 Tax Tips series. Robert Flach is an expert with almost 40 years of experience as a tax professional and also blogs as The Wandering Tax Pro.

NEW YORK (MainStreet)—All too often during the tax filing season my explanatory memo to clients includes the following statement:

"Because of the way Social Security benefits are taxed, for every additional dollar you receive, you are taxed on $1.85!"

The amount of Social Security or Railroad Retirement benefits that are subject to federal income tax depends on the amount of your other income - both taxable and tax-exempt.

The calculation of taxable benefits starts with one-half of your gross Social Security or Railroad Retirement benefits (from Box 5 of Form SSA-1099 or RRB-1099) – combined if filing a joint return.

To this number you add all other taxable income (Form 1040 Lines 7, 8a, 9a, 10-14, 15b, 16b, 17-19, 21).

Next you add the amount of tax-exempt interest reported on Box 8b of Form 1040. While municipal bond interest is exempt from federal income taxation, it is included in the calculation of taxable SS or RR benefits – so up to 85% of tax-exempt municipal interest could be subject to federal income tax.

From the total of these three amounts you subtract the total "adjustments to income" from Form 1040 line 23 – 32 plus any write-in adjustments included in Line 36. Deductions for student loan interest, tuition and fees, and domestic production activities, the adjustments reported on Form 1040 lines 33, 34, and 35, are not allowed in calculating taxable benefits.

If this amount - one-half of benefits plus other taxable income plus tax-exempt interest less most adjustments to income - exceeds $25,000, or $32,000 for married couples filing a joint return, up to 50% of your benefits will be taxed. If the excess exceeds $34,000 or $44,000 respectively, up to 85% of your benefits will be taxed.