Tax Relief for Seniors
It is a trend I've started to notice in recent years as a tax professional - my oldest clients are the ones with the largest tax bills. There are a few things that play into this, and I'm going to share them here along with a potential solution that seems to be hanging within our reach.
Why are our seniors paying so much in taxes? Most people think that a hard-won retirement will leave them sitting in an easy chair with a lower tax burden, but I've watched that illusion fade away in recent years. With increased inflation retirees are pulling more out of retirement accounts and much of that income comes in at a higher tax bracket resulting in increased taxes. It's a double hit if you will. You need more to live on, and that added money is going to be taxed at a higher rate. Leveled on top of that hit is the fact that most retirees pay tax on their social security benefits. For many, that's a hard pill to swallow.
The taxation of social security benefits came about during the Regan administration via the Amendments of 1983, and the taxation of benefits was officially implemented in 1984. This tax was originally designed to impact only higher income senior households. Initially, in 1984 when the tax on benefits was implemented only up to fifty percent of your benefits could be taxed. The rationale for taxing half the benefits is that the social security tax is split with half being paid by employees and half being paid by employers. The employee's half is included in taxable wages, but the amount paid by the employer is not. In 1993, the Clinton administration created another tier of taxation whereby up to eighty-five percent of benefits were able to be taxed. The threshold at which those benefits become taxable has not been changed in more than forty years. That's right folks, they have never adjusted those tax thresholds for inflation so unfortunately most seniors collecting social security will pay tax on their benefits. The income threshold for taxability is ridiculously low at $25,000 for a single taxpayer and $32,000 for married couples and that income amount includes one-half of your social security benefits. Under the current thresholds it's almost impossible to avoid tax on your social security benefits.
Coupled with a higher cost of living that requires other and added sources of income, the result is that more seniors than ever are paying tax on their social security benefits and some of these seniors are having their social security income pushed into higher income tax brackets which only adds to the insult. When I look back ten years ago only a few of my older clients had taxes withheld from their social security benefits, now almost all of them are having taxes withheld or are making estimated tax payments to cover the shortfall. Clients that do not prepare for this situation find themselves with a balance due at filing time. The system is indeed broken.
On the federal level income is taxed based on seven federal income tax brackets with rates ranging from ten percent to thirty-seven percent. As income climbs from one bracket into another the income in the next bracket is taxed at a higher rate and as the income rises you move from bracket to bracket. For single people, the tax bracket changes from twelve percent to twenty-two percent at approximately $45,000 of taxable income (married people $90,000). You can use things such as deductions and tax credits to lower the taxable income. Families with young children or college students and working people funding retirement can often significantly reduce their tax liability with the credits and deductions available to them. Unfortunately, seniors don't have much in the way of tax deductions or tax credits so often end up with income being taxed in higher brackets.
Currently being touted is Donald Trump's pledge to end the tax on social security benefits. Questions exist – Can he do it? Possibly, but it's not solely within his power to do this. Congress would have to pass a law ending the tax, and it could be difficult to accomplish. Will it happen? Again, possibly. Republicans currently control the House and Senate making the likelihood more possible. Opponents of the plan complain that it would take away one of only three sources funding the program and speed up the demise of the program. Currently the program can only continue to pay full benefits until 2035, at which time the trust fund reserves are expected to be depleted and retirees will endure a 23% benefit cut. It's likely that before this happens the government will take steps to increase the program's funding. At a minimum, much needed broader Social Security reforms need to be enacted that could help everyone.
If you're wondering if they should remove the tax on social security benefits my short answer is a resounding YES! For too many years I've watched seniors struggling with an increasing tax burden in the midst of high inflation, and we can do better. Our current system of taxing social security benefits is financially punishing the very people the system was intended to provide for. It's time to make the lives of our seniors a little more golden!