Tax Exempt Income May Still Result in You Paying Taxes

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Uncertain when tax exempt income may be taxable? Many people are confused when it comes to tax exempt income.

Tax exemption means the income is excluded from being taxed. Because municipal bonds are one of the few ways that individuals can earn interest and dividends that are exempt from federal taxes, a lot of investors flock to them. But, what some people don’t realize is that while the tax exempt interest is and of itself tax exempt, the amount of that income is included in the calculation to determine what amount of their Social Security benefits may be taxable. So when people begin receiving their Social Security benefits, they will have to begin every year doing an additional calculation which will include tax exempt income, to help determine what percentage of their Social Security benefits may be taxed.

Another way that tax exempt income becomes taxable is for those whose income is over approximately $200,000 for individuals or $250,000 for couples. For those individuals or couples, their otherwise tax exempt income is now lumped together with their taxable income. They face the potential of a 3.8% Medicare surtax on the total amount of their income (i.e., taxable + tax exempt).

How might tax exempt income affect you?

To help determine what percentage of your Social Security benefits are taxed, tally up all of your income including wages, retirement income (i.e. pension income, IRA distributions, profit sharing distributions, basically anything that produces a 1099R), dividends, interest, capital gains, K1 distributions, and tax exempt dividends or interest. Depending on what that total is, the amount of your Social Security benefits that will be included in your taxable income will be determined using one of the two thresholds: 50% or 85%.

If you are a single filer of tax returns that have a combined income between $25,000 and $34,000 have to pay taxes on up to 50% of Social Security benefits. If your income is over $34,000, then up to 85% of your Social Security benefits are taxable. If you are filing married and jointly, and your combined income is $32,000 to $44,000, then up to 50% of Social Security benefits are taxable. If your combined income is more than $44,000, then up to 85% of your Social Security benefits may be taxable.

Are you still confused?

Give us a call and we can determine if your tax exempt income might actually result in an increase of your tax liability.