Social Security Benefits and Potential Tax on Benefits
By: Patricia T. Henssler, C.P.A.
The Henssler Financial Group Position Paper

The 1939 Amendments

The 1939 Amendments made a fundamental change in the Social Security program. It added two new categories of benefits: payments to the spouse and minor children of a retired worker (dependent benefits) and survivors benefits paid to the family in the event of premature death of covered workers. This change transformed Social Security from a retirement program for workers into a family-based economic security program.

The 1939 Amendments also increased benefit amounts, which were fixed (no Cost of Living Allowances), and accelerated the start of monthly benefits payments to 1940. The first monthly retirement check was issued January 31, 1940 in the amount of $22.54. Ida May Fuller retired in November 1939 at age 65 and lived to be 100 years old. The accumulated taxes on her salary for the 3 years she participated were $24.75. During her lifetime she collected $22,888.92 in Social Security benefits. (Do the math. Now you can see why Social Security tax rates and wages subject to Social Security tax have increased dramatically — to replenish the pot.)

The 1950 Amendments and "COLA"

From 1940 until 1950, virtually no changes were made in the program. Because the program was in its infancy and because it was financed by low levels of payroll tax, the retirement benefits were very low. Old-age welfare benefits were higher than retirement benefits received under Social Security.

In 1950, amendments increased benefits for existing beneficiaries for the first time and increased the value of the program to future beneficiaries by providing Cost of Living Allowances (COLA), as legislated. Ida May Fuller's retirement benefit had been $22.54 per month for 10 years. With this recomputation and change, her October 1950 check was $41.30. After 1950, benefits were only increased when Congress enacted special legislation.

In 1972, the law was changed to provide automatic annual COLA based on the annual increase in consumer prices beginning in 1975.

Disability

In 1954, a disability insurance program was added. Initially the program only kept your benefit periods alive while you were disabled so that you could receive higher benefits at retirement. In 1956, the act was amended to provide benefits to disabled workers aged 50-64 and disabled adult children. In 1960 the law was amended to permit payment of benefits to disabled workers of any age and to their dependents.

Medicare, SSI, and the 70s

Under the amendments of 1961, the age at which men are first eligible for reduced retirement benefits was lowered to 62 (women were given this option in 1956). In July 1965 the Medicare bill was signed which extended health coverage to almost all Americans aged 65 or older. Nearly 2 million enrolled in the first 3 years.

In the 1970s Supplemental Security Income (SSI) was introduced. In the original act, programs were introduced for needy-aged and blind individuals, and needy-disabled individuals were added in the 50s. However, these programs were administered by the states and only partially funded with federal dollars. In 1972, Congress federalized these categories and assigned it to the Social Security Administration.

The 1972 amendments also provided for certain other increased benefits: a minimum retirement benefit; an extension of Medicare to those receiving disability benefits for at least 2 years; liberalized the Retirement Test; and provided for Delayed Retirement Credits to increase the benefits for those working past age 65.

The 1977 amendments raised the wage base, reduced benefits slightly, and changed the method for calculating COLA. The last was an important change, as the prior method would have had retirees collecting more from Social Security than they had received in gross salaries while working.

Taxing Your Benefits

The 1983 bill made numerous changes to the Social Security and Medicare programs including adding Federal employees to Social Security and increasing the retirement age from 65. It also included the taxation of Social Security benefits.

As we know, the legislature and the IRS cannot make this easy. In 1983 there was one standard, whereby up to 50% of your Social Security benefits could be taxable for federal income tax purposes (most states do not tax Social Security income). Since 1994, up to 50% of benefits were taxable at one income level and up to 85% were taxable for higher income levels. Now keep in mind that Social Security benefits are, in theory, those taxes withheld from your pay and matched by your employer. This is, in effect, a tax on a tax.

How much of your Social Security income is taxed depends on your "provisional income." Provisional income is the taxpayer's "modified adjusted gross income" plus one-half of your Social Security benefits. "Modified adjusted gross income" is your adjusted gross income plus all tax-exempt income (yes, I mean that tax-free municipal bond interest) Fifty percent of the excess "provisional income" over a base amount ($32,000 for married filing joint, $25,000 for single) is taxable, up to 50% of your benefit.

For those taxpayers whose provisional income is in excess of $44,000 (MFJ) or $34,000 (single), up to 85% of their benefit can be taxable. The worksheet and explanation to calculate the taxable amount is beyond the scope of this article. For tax projection purposes, if your provisional income is in excess of $44,000, assume that 85% of your Social Security benefits will be taxable — you probably will not be off by much.

A Benefits Primer