You may think that government benefits are tax-free, but that isn’t necessarily the case. In fact, several of the most common benefits claimed by Americans – unemployment, Social Security, and disability – do generate a tax bill. If you receive government benefits, understanding and keeping track of what can be taxed is key to getting the most out of the program and not setting yourself up for any unpleasant surprises.
At first glance, this may seem difficult. However, there are several fairly simple steps to understanding how much tax you must pay on your benefits each year.
Here are a few things to keep in mind if you’ve received unemployment benefits over the course of the past year:
1. Unemployment Benefits Are Taxable
In 2009, thanks to the The American Recovery and Reinvestment Act, you were able to receive up to $2,400 of unemployment payments without having to pay a penny in federal tax. However, this benefit lasted only for one year, and since 2010, all unemployment benefits are taxable as ordinary income. At the end of the year, you should receive Form 1099-G with the amount of benefits you received, which you need to report on your tax return.
2. Opt for Voluntary Tax Withholding
You can avoid a big tax bill at the end of the year by filling out Form W-4V, which is a voluntary tax withholding request form. In doing so, the Federal Government withholds 10% of your unemployment check in the same way that a normal employer would. You can also request federal income tax to be withheld from your Social Security benefits, Social Security equivalent Tier 1 railroad retirement benefits, your Commodity Credit Corporation loans, or certain crop disaster payments under the Agricultural Act of 1949 or under Title II of the Disaster Assistance Act of 1988, at the rate of either 7%, 10%, 15%, or 25%.
If you aren’t currently having taxes withheld from your unemployment checks, it’s advisable to start. Fill out Form W-4V and send it to the office that handles your unemployment payments. For unemployment benefits, 10% is the only amount you can have withheld.
3. Factor In Additional Money Received
Any severance payments or money you received from unused sick days or vacation time is considered to be taxable income as well. What’s more is that your employer may not have withheld taxes from these sums.
Many individuals who receive Social Security benefits also have a pension, a second or part-time job, investment income, or other money coming in from various sources. This may raise your income such that your Social Security benefits become taxable.
Generally, if the only income you receive is from Social Security, you won’t owe any taxes. However, if you earned or received any other money during the year, you should determine whether the money you received from Social Security is going to be classified as taxable income.
1. Determine Your “Base Rate”
The base rate for your filing status helps determine whether some or all of your Social Security benefits are taxable. The base rates for the 2015 tax year are as follows:
- $32,000 for married couples who file jointly
- $25,000 for single filers, head of household, or qualifying widow/widower with a dependent child, or if you are married and filing separately but did not live with your spouse during the year
- $0 for married persons who file separately and lived together at any time during the year
2. Do the Math
Next, take all of the income you earned from other sources (not Social Security income), including any income that is otherwise tax-exempt, and add half of the money you received from Social Security to this amount. If the total is more than your base rate (listed above), some of your Social Security benefits are taxed. If it is less, they won’t be taxed. The exact amount depends on your specific tax situation.
For example, consider Claire and Daniel, who both receive Social Security benefits. Claire received $10,000 in Social Security benefits, while Daniel received $13,000. Their investments produce an income of $11,000, and Daniel has a pension that paid him $15,000.
- Claire’s Social Security: $10,000
- Daniel’s Social Security: $13,000
- Investments: $11,000
- Pension: $15,000
To determine whether any of their benefits are taxable, take half of their total Social Security income:
($10,000 + $13,000) / 2 = $11,500
and add it to their other income:
$11,500 + $11,000 + $15,000 = $37,500
Recall that their base rate as a married couple filing jointly is $32,000. Since the total, $37,500, is above that amount, some of their benefits are taxable.
3. Social Security Tax Limits
You can never be taxed on more than 85% of your Social Security benefits. To calculate exactly how much tax you can expect to pay, fill out Worksheet 1 in IRS Publication 915.
- Individuals: If your total combined income (as figured from Worksheet 1) is between $25,000 and $34,000, you generally pay income tax on about 50% of your Social Security benefits. If your total combined income is greater than $34,000, you may have to pay tax on up to 85% of your Social Security benefits.
- Married Couples Filing Jointly: If your total combined income (as figured from Worksheet 1) is between $32,000 and $44,000, you generally pay income tax on about 50% of your Social Security benefits. If your total combined income is above $44,000, you may have to pay tax on up to 85% of your Social Security benefits.
- Married Couples Filing Separately (Who Also Lived Together): You likely must pay tax on your Social Security benefits no matter what.
Disability payments can cause confusion during tax time. If you are receiving disability through the Federal Government, you must use the same rules as those for Social Security to determine whether they are taxable. However, if you participated in a disability insurance plan through your employer, you may be taxed on the proceeds.
Premiums vs. Payouts
The important distinction here is that the Federal Government taxes either the premiums you paid to the insurer, or the payouts you receive if you claim disability. You are not taxed on both.
Some employers provide disability insurance as a benefit to their employees at no cost. If you receive such an employee benefit and do not pay tax on the benefit received, you’re required to pay taxes on disability payments received. However, if you purchase additional disability coverage that you pay for with after-tax funds, any benefits you receive are not taxable.
Assistance That Is Never Taxed
There are many kinds of government benefits that are never taxed. You should not include amounts for assistance in these categories in your income for tax purposes.
- Welfare or other public assistance based on need
- Work training payments, as long as they do not exceed what you would have received in welfare payments
- Food stamps or other nutrition assistance programs, such as elderly assistance, or women, infants, and children programs
- Disability rehabilitation training and assistance due to your disability, such as transportation
- Disaster relief grants, disaster relief payments, or disaster mitigation payments
- Mortgage assistance programs
- Replacement housing payments or relocation payments
- Winter energy bill reductions
- Medicare part A or B benefits
- Veterans’ benefits, such as medical care, disability payments, education, or death gratuities
- Workers’ compensation benefits if paid under a workers’ compensation act
If you receive any kind of government benefits, it is extremely important to keep track of what’s taxable and what’s not. While the amount of information and number of guidelines can be overwhelming, it’s worth taking the time to educate yourself. A little extra effort can help you avoid a big tax bill when the tax-filing deadline rolls around.
Did you receive any government benefits this year?