Did Tax Reform Solve My Social Security Tax Problems?

Retirees depend on Social Security for their well-being, and most of them see their benefits as a well-earned right after paying Social Security withholding tax throughout their careers. Yet as many people have only discovered after the fact, there are situations in which Social Security income can be taxable. That effectively takes away some of those hard-earned benefits, which is especially painful for retirees looking to survive on fixed incomes.

Last year’s tax reform efforts resulted in sweeping change for taxpayers, with many eligible to take advantage of higher standard deductions and bigger tax breaks for parents and businesses. However, some who had hoped that tax reform might solve the Social Security tax problem that millions of retirees face weren’t entirely satisfied by the legislation’s response to their difficulties.

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Why 20 million people pay taxes on their Social Security benefits

Social Security hasn’t always been taxable. But in the early 1980s, when the program faced its first major financial crisis, lawmakers decided that it would make sense to raise some revenue to help support Social Security by making a portion of benefits taxable. At that time, income tests were introduced, above which up to half of all benefits would be subject to tax.

Those income limits — $25,000 for single filers and $32,000 for joint filers — seem comically small by today’s standards. In the early 1980s, though, it was relatively rare for those receiving Social Security to have incomes anywhere near those figures. Moreover, to calculate those income limits, you didn’t have to consider all of your income sources in full. Only half of your Social Security benefits were included in the calculation, in addition to any income from sources like wages, investments, or taxable pensions.

Later on, lawmakers added a second tier of taxability for Social Security. Above a second set of threshold income levels — $34,000 for single filers and $44,000 for joint filers — you would potentially have to report up to 85% of your Social Security benefits as taxable income. Now, those levels capture 20 million retirees who have to report at least some amount of their Social Security as being taxable.

The problem — and what tax reform did to solve it

The mistake that lawmakers made when they enacted the provisions subjecting Social Security benefits to taxation was that they ignored the potential impact of wage inflation over the years. Unlike many tax provisions, the laws governing Social Security taxation didn’t incorporate any adjustments for inflation into the calculation.

In considering tax reform, lawmakers today had the chance to look closely at these provisions and suggest a fix. Some would have suggested making Social Security entirely tax-free, while others might have been content just to tie those threshold income numbers to inflation.

Yet the final tax reform package didn’t have anything that directly affected what Social Security recipients are required to report as taxable income. The same low income numbers appear, and they’re still not indexed for inflation.

A consolation prize

The only thing that tax reform did to give Social Security recipients some relief was to reduce the tax rates at which that income gets taxed. With former brackets ranging from 10% to 39.6% giving way to new brackets with rates of 10% to 37%, many taxpayers saw reductions of between one and four percentage points to their tax rates. So to the extent that those getting Social Security had to include their benefits as taxable income, those lower rates would have reduced the tax burden they had to bear.

Nevertheless, the fact that seniors still have to pay any tax at all on Social Security benefits comes as an affront to many older Americans. Until broader-based tax reform becomes reality, a rising number of retirees will have to consider whether they’ll end up losing some of their Social Security retirement income diverted to the coffers of the IRS.

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