During his campaign, Donald Trump promised to end taxes on Social Security benefits. This would seem like a welcome relief for your retired clients who have enough other income to cause them to pay federal income tax on 85% of their benefits.
But when you consider the impact on the Social Security trust fund, the proposal may not be so great.
Income taxes on benefits added about $50 billion to the trust fund last year. Without that income—and with the loss of payroll taxes arising from other Trump proposals, Social Security’s finances would worsen and could threaten future benefit amounts.
Trump promised not to cut Social Security benefits, but if his proposals would accelerate already-projected cuts and compress the timeline in which Congress must act to restore solvency to the system, clients will be nervous at best, and possibly worse off financially.
The ones who will make out the best are those who already pay tax on 85% of their benefits, are in a high tax bracket, and whose tax and benefit cuts (if it comes to that) end up in a net wash. Worse off will be those who have managed to avoid or minimize taxes on their benefits, either through smart tax planning or an unfortunate lack of resources, who won’t be taking full advantage of the tax cut, and will face the same benefit cuts (if it comes to that).
Figuring your tax
Recently the IRS helpfully released this Notice 703: Read This to See if Your Social Security Benefits May be Taxable. This form doesn’t figure the tax itself, but is the first step in determining if your benefits might be subject to income tax.
All you do is take your total Social Security income (line A), multiply it by .50 (line B), add all your taxable income, not reduced by deductions or exclusions (line C), plus municipal bond interest (line D), and put the total on line E. Then compare the amount on line E to the base amount for your filing status: Single, head of household or qualifying surviving spouse $25,000; married filing jointly $32,000; married filing separately zero. If the amount on line E exceeds these thresholds, part of your benefits will be taxable.
Determination of the actual tax is more complicated. That worksheet can be found in IRS Publication 915, or your tax software or at the hand of your tax preparer. What’s tricky is the “up to” provision of either the 50% or 85% of benefits subject to tax.
Anyone who is marginally over the threshold will pay tax on just the amount by which provisional income exceeds the threshold. See Chapter 8 of Horsesmouth’s Financial Advisor’s Guide to Savvy Social Security Planning for examples.
Because these base amounts were never adjusted for inflation, many of your clients’ provisional income will be well over their respective base amounts and they will be reporting 85% of their Social Security benefits as ordinary income on their tax returns. These are the ones who will be helped the most by Trump’s proposal—if it passes.
What about the trust fund?
The Committee for a Responsible Federal Budget (CRFB) has analyzed the effects of Trump’s proposals and found that they would widen Social Security’s cash deficits.
In its report What Would the Trump Campaign Plans Mean for Social Security? it found that Trump’s agenda would:
- Increase Social Security’s 10-year cash shortfall by $2.3 trillion through FY 2035.
- Advance insolvency by three years, from FY 2034 to FY 2031—hastening the next president’s insolvency timeline by one-third.
- Lead to a 33% across-the-board benefit cut in 2035, up from the 23% Congressional Budget Office projects under current law.
- Increase Social Security’s annual shortfall by roughly 50% in FY 2035, from 3.6% to 4% of payroll.
- Require the equivalent of reducing current law benefits by about one-third or increasing revenue by about one-half to restore 75-year solvency.
Proposals from President-elect Trump that would weaken Social Security’s finances include:
- Ending taxation of Social Security benefits, which would eliminate a revenue stream currently used to help finance Social Security.
- Ending all taxes on overtime pay and tips, which would reduce payroll tax collection accruing to the Social Security trust funds.
- Imposing large tariffs on imports, which would either increase cost-of-living adjustments (COLAs) through higher inflation or reduce taxable payroll.
- Enhancing border security and deporting unauthorized immigrants, which would reduce the number of immigrant workers paying into the Social Security trust funds.
These proposals would also affect Medicare. An earlier analysis, in July, which dealt only with the elimination of taxes on Social Security benefits, the CRFB found that the HI (Part A) trust fund would run out six years earlier than current projections.
Realistically, these measures are not likely to pass Congress. Any changes to Social Security would require at least 60 votes in the Senate, and Republicans have just 49 seats. Republicans tend not to vote for measures that increase deficits anyway.
We may have to chalk this proposal up to a campaign promise that may have gotten Trump some votes but isn’t workable in the end. At least it brings attention to Social Security’s finances and will maybe ignite some interest among members of the new 118th Congress in finally getting it fixed.