Taxing Social Security
Brian F. Chrest, CPA
Strategic Planner at Chrest CPA Tax Planning | Family Owned Business Tax Planner | Servant Leader | Provider of Peace | Business Owner Coach | Lover of Baltimore
A Synopsis of the Taxation of Social Security Benefits
When the Social Security system began over eighty years ago, the receipt of Social Security benefits was specifically excluded from taxable income. This was an unusual Treasury ruling because at that time (and still today) conventional retirement plans made the portion of benefits attributable to earnings and employer contributions taxable, while exempting employee contributions.
This tradition continued for over 40 years until the early 1980’s when the Social Security system began facing some financial issues. Congress established the Greenspan Commission to study the issue, and they proposed making the roughly 50% portion of Social Security taxes paid by the employer taxable to the employee at withdrawal starting in 1983. The income threshold of taxable benefits resulted in the Commission estimating that its proposals would affect only about 10% of Social Security beneficiaries and that it would result in $30 billion in revenue to the Trust Funds in the first seven years.
About ten years later Congress decided to also go after the equivalent earnings that were sheltered inside of Social Security. Remember, Social Security is made up of three parts (primarily): worker taxes; employer taxes; and earnings on both amounts. In 1993, as part of the Omnibus Budget Reconciliation Act, the Social Security taxation provision was modified to add a secondary set of thresholds and a higher taxable percentage for beneficiaries who exceeded the secondary thresholds.
The changes introduced by the 1993 amendments were designed to make the treatment of Social Security benefits more closely approximate to private pensions. To this end, the taxable percentage was set at 85% for higher-income beneficiaries. New thresholds were added, but only to differentiate those subject to the higher percentage from those still subject to the 50% figure. Inflation has left those thresholds in the dust of political promises.
So within a ten year span, America had gone from no tax on any portion of the three elements of Social Security benefits, to taxation of two of the three pieces: the equivalent employer contribution becoming taxable in 1983 and the equivalent earnings becoming taxable in 1993.