by Julian Block
Americans often dream about a simplification of the Byzantine Internal Revenue Code, only to awaken and find the tax laws becoming more complicated.
The rules for Social Security benefits are especially convoluted and confusing. Although most Social Security recipients escape income taxes completely on all of their benefits, middle- and upper-income level retirees have to count up to 85% of their benefits as reportable income.
Gift of the MAGI
Taxes are triggered for Social Security recipients when their MAGI exceeds specified amounts. MAGI is an acronym for modified adjusted gross income, which in most instances is essentially the same amount as adjusted gross income.
To calculate whether MAGI surpasses the tax-triggering thresholds, retirees must consider income from various sources such as: salaries, pensions, dividends, capital gains, rents, Roth conversions (money moved out of traditional IRAs and into Roth accounts), and required
minimum distributions RMDs starting at age 70½ from traditional IRAs, 401(k)s, and other retirement plans.
The wide-ranging MAGI tally for Social Security benefits also includes whatever retirees receive as tax-exempt interest from municipal bonds (obligations issued by state and local governments) or from muni bond funds, as well as 50% of Social Security benefits. Table 1 shows how to calculate MAGI.
Table 1. Calculating Modified Adjusted Gross Income (MAGI)
A Social Security Benefits (annual total)
B Calculate Half of Line A
C Adjusted Gross Income (pensions, wages, dividends, Roth conversions, etc.)
D Tax-Exempt Interest Income (e.g. interest from municipal bonds)
Take, for example, a married couple who have Social Security benefits of $28,000, adjusted gross income of $31,000, and tax-exempt interest of $5,000 for a total of $64,000. Their MAGI is $50,000 (see Table 2 ).
Table 2. Example of MAGI Calculations