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Retirees are almost guaranteed to get a big Social Security cost-of-living-adjustment (COLA) next year due to persistent, sky-high inflation. And while that’s good news for those struggling financially with rising prices, some seniors should also prepare for a potentially higher tax bill.
The 2023 COLA will be announced next week, after the U.S. Bureau of Labor Statistics releases September’s inflation numbers. And depending on those figures, Social Security checks could increase by more than 8.6% in 2023. There was a 5.9% adjustment this year.
That’s no doubt a relief for the millions of people on fixed income who have lost much of their purchasing power as inflation has taken its toll. But with that relief comes a potentially higher tax burden.
How Social Security is taxed
Those who have income in addition to their Social Security checks are on the hook to pay federal income tax on up to 85% of their benefits.
If and how much you are taxed depends on your tax status and income. It is based on a beneficiary’s provisional income, which is equal to half of their (and their spouse’s) Social Security benefit plus their modified adjusted gross income and nontaxable interest:
- Individuals who earn between $25,000 and $34,000 may pay income tax on up to 50% of their benefits. Those who earn more than $34,000 may pay taxes on up to 85% of their benefits.
- Couples filing jointly with a combined income between $32,000 and $44,000 may pay income tax on up to 50% of their benefits. Those who earn more than $44,000 may be taxed on up to 85% of their benefits.
If the COLA pushes you above those income thresholds, then you could be on the hook for paying more in taxes (and your Medicare Part B premiums could increase as well).
Notably, these income thresholds have not been adjusted for inflation since they were established decades ago. “Rising benefit levels subject more benefits to taxation,” reducing the net benefit and applying to more beneficiaries over time, according to a report from the Center for Retirement Research at Boston University.
When the taxation of benefits was first introduced in the 1980s, 8% of eligible families paid taxes on their benefits, according to the report. Today, an estimated 56% of beneficiary families pay taxes.
“Had these income thresholds been adjusted for inflation the $25,000 level would be about $72,660 and the $32,000 level would be $93,000,” says Mary Johnson, Social Security and Medicare policy analyst at the Senior Citizens League.
If the only income you receive is Social Security, then it is unlikely that you will be taxed on your benefit. But if you and your spouse have any other kind of income, then you could easily surpass those thresholds.
That said, it is possible that beneficiaries wouldn’t pay more, depending on how the IRS tweaks the tax brackets and standard deduction for next year, according to Johnson.
“That may offset the additional portion of taxable Social Security benefits,” she says. That information will be released later this month or in early November.
In addition to federal income tax, 13 states also tax Social Security benefits: Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, New Mexico, North Dakota, Rhode Island, Utah, Vermont, and West Virginia.
If you owe taxes, you can ask the government to withhold them from your Social Security payments throughout the year so you won’t have a big bill come tax season.
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