Perspectives on the Taxation of Social Security Benefits - AMAC Foundation, Inc.
President Trump has led the most recent charge to rescue Social Security beneficiaries from the pain of income tax assessments, but that’s certainly not the first time the thought has emerged. Through the years, many have argued that including a portion of one’s Social Security benefit in taxable income is unjust, since the benefit itself is the product of work that has previously been taxed. There are counterarguments that show it’s technically not “double taxation,” but these econometric arguments usually only serve to reinforce perceptions of unfairness surrounding this 40-year-old tax rule. Then, there’s the point that simply removing the tax would further exacerbate Social Security’s unraveling financial situation unless a source of compensating revenue is found.
Fast forward to where we are today, with the recent “no tax on Social Security” movement emerging from the One Big Beautiful Bill Act signed into law in July. Although touted as tax elimination, lawmakers were forced to develop a workaround using additional income deductions to accomplish this objective. In reality, this workaround is a temporary measure that applies only to tax years 2025 through 2028, so the issue persists for seniors.
The Potential for Compromise?
What usually happens in this ongoing argument is that a compromise is sought, and that often leads to a discussion of alleviating some of the angst by modernizing the thresholds that determine when the tax kicks in, since these parameters have never been adjusted since their 1983 and 1993 enactments. In fact, the Social Security Office of the Chief Actuary has analyzed five separate proposals addressing this vexing taxation issue, some seeking to phase it out completely, some compromising on the thresholds, and at least one seeking to expand it to apply the tax in the same manner as taxation on private pensions. Similarly, the AMAC Social Security Guarantee recommends either exempting Social Security benefits from federal income tax liability altogether or adopting updated thresholds.
Looking at Some of the Fundamentals
What will eventually happen in this area is anybody’s guess at this point, since enacting a change like this involves multiple financial moving parts. In the meantime, as our readers develop their own conclusions on an appropriate solution, we thought it would be interesting to provide some fundamental facts about the structure of this specific tax policy. First, there’s the general question of why and when this all started. This page on Congress.gov provides the answer: “The taxation of Social Security benefits began with the Social Security Amendments of 1983. There were two primary reasons for taxing Social Security benefits. The first was to improve tax equity by treating Social Security benefits more like other forms of retirement income and other income designed to replace lost wages. The second was to provide revenue to strengthen the financial solvency of the Social Security trust funds.”
Next, let’s consider the calculation of the tax itself. As you may know, the amount taxed is labeled “provisional income” and generally corresponds to modified adjusted gross income plus 50% of Social Security benefits. So, why 50% and not 100%? It seems the original thinking was that since the employee and employer both paid the same FICA rate, and since the employer was able to deduct their 50% as a business expense, only the employee’s portion of the payroll tax made it into the program revenue bucket.
An even more intriguing question is the origin of the 85% ceiling. Here, I’ll draw on commentary from respected Social Security expert Devin Carroll, CFP®, who quotes governmental sources: “… A worker with average earnings who lives to an average age contributed payroll taxes that equal about 15% of their total expected lifetime benefit amount.” In his research paper on the subject, Carroll uses an average career lifetime benefit of $400,000, on which about $60,000 would have been paid in payroll tax. $60k divided by $400k is 15%, meaning that the remaining 85% of the benefit should logically be taxed. Carroll points out that these average assumptions are just that — averages — and that workers with career earnings more than the national average wage would have paid a higher level of tax. Depending on their other income, they could end up paying more than the average payroll tax.