Can someone pay more taxes than his income?

Yes, if that person is a senior citizen

Some senior citizens are subject to two special taxes that, in combination, produce marginal tax rates that can EXCEED income.  First, there is the tax on 85% of Social Security benefits for taxpayers with “provisional income” over certain threshold amounts.¹ (Essentially, provisional income is adjusted gross income plus tax-exempt interest and one-half of Social Security.)  This is a complicated tax that necessitates the use of paid tax preparers, and it is partly a double tax because FICA is also taxed (partially) when first withheld. 

The other tax is de facto in nature.  It is commonly referred to as the “work penalty.”  Social Security recipients of ages 62 through full retirement age² lose one dollar of Social Security benefits for every two dollars earned beyond $12,000 (the amount for 2005).  This is the equivalent of a 50% tax – on top of all the other taxes to be paid.

 When you put the two taxes together, along with other income and payroll taxes, the results are surprising and disturbing.  Here is an example from the book, How Social Security Picks Your Pocket (Joe Fried, Algora Publishing, 2003) (Updated for 2004 rates).         

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Let’s pretend you have a good friend in Ohio who is single and age 63, and who has the following amounts of income:  wages-$12,000, interest-$500, private pension-$17,500, and Social Security-$16,000.

Your friend needs advice.  She wants to help her daughter with college expenses, and has travel plans, but she is a bit short on money.  She has a chance to earn $5,000 more by increasing her hours at work. Should she work the extra hours to earn more money?

Before you answer, consider the following breakout of her taxes, statutory and de facto, on the extra $5,000 she wants to earn:

If your friend works those extra hours, she will pay $5,517 in taxes (formal and de facto) on the $5,000 she earns.  I hope she is not planning on a trip to Maui. 

 

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Ironically, this inequitable double tax is more than offset by the UNDER-TAXATION of benefits for vast numbers of Social Security recipients.  If we were to tax Social Security benefits in the same simple way we tax most pension  benefits, more equity would be achieved, AND OUR PENDING SOCIAL SECURITY INSOLVENCY COULD BE CUT BY AS MUCH AS 24%.  On this point, the Social Security Advisory Board (an independent, bipartisan board created by Congress and appointed by the President and the Congress to advise the President) notes:

Under present law, Social Security benefits are taxable only if income is above specified thresholds.  One alternative [among deficit reduction proposals] would be to phase out the thresholds and tax benefits in a manner similar to that for contributory private pension income. Phasing out the lower thresholds during 2002-2011, taxing benefits similar to private pensions, and putting all additional revenue raised into the Social Security Trust Funds would eliminate 24 percent of the deficit.³

While it is true that the change suggested by the Advisory Board would mean a tax increase for some Social Security beneficiaries, our progressive tax structure should eliminate or minimize the tax for those with little total income.  In fact, it was estimated by the American Academy of Actuaries that, even with the full taxation of benefits, 30% of beneficiaries would not pay tax, simply due to the standard deduction and exemptions.⁴

Finally, it should be noted that MANY SENIORS HAVE NO IDEA THAT THEY ARE PAYING MORE TAX THAN THEY EARN.  As a result, they work at jobs despite the fact that they receive NO FINANCIAL BENEFIT from those jobs.  It is appalling that we would subject senior citizens to a 110% tax, and it is even more appalling that we would make the tax so complex that many of them can not understand it.  It is time to reform the taxation of Social Security benefits.

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1. The thresholds are $34,000 for single filers, $44,000 for joint filers, and $7,950 for married people filing separate returns (i.e., the sum of their standard deduction and personal exemption).

2. Full retirement age is gradually being increased to age 67.   For example, it is 67 for all born in 1960 or later, it is 66 for those born in 1943-1954, and it is 65 for those born in 1937 or earlier.

3. “Social Security:  Why Action Should be Taken Soon,” [online] (Social Security Advisory Board, July 2001– [cited 27 October 2002]), 23; available from http://www.ssab.gov/Publications/Financing/actionshouldbetaken.pdf. 

4. “Social Security Benefits:  Changes to the Benefit Formula and Taxation” [online] (American Academy of Actuaries, October 2002– [cited 15 November 2002]); available from http://www.actuary.org/socsec/index.asp.

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Date last modified May 7, 2008