When tax time rolls around each year, some older Americans are surprised to discover that a portion of their Social Security benefits are taxable. Since the government doesn’t automatically withhold taxes from benefits, it could mean some beneficiaries end up owing the IRS in April.
Meanwhile, the Social Security trust funds are slowly running dry, and the Old-Age and Survivor Insurance Trust Fund — which pays out retirement benefits — will be depleted in 2031, according to current estimates. After that, the Social Security system will only be able to pay out 89% of benefits owed, according to a recent report from the Trustees of the Social Security and Medicare trust funds.
“The system is a mess, and it’s underfunded and needs reform and no one wants to do it,” says Brett Walters, a financial planner with TBH Advisors in Brentwood, Tennessee.
However, with a Social Security shortfall looming, legislators may be feeling more pressure to come up with a fix. One bill introduced this year aims to prop up the trust fund balance while also providing a tax break to Social Security beneficiaries.
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What Is the Bill That Would Eliminate Social Security Taxes?
The You Earned It, You Keep It Act was introduced in January by Rep. Angie Craig, D-Minn. The bill contains two main provisions:
— Elimination of federal income tax on Social Security benefits.
— Assessment of Social Security payroll taxes on incomes of $250,000 or more.
For 2024, Social Security payroll taxes are assessed on incomes up to $168,600. The 12.4% tax is split between employers and employees. Self-employed workers are responsible for paying the entire amount themselves.
As currently written, the bill would create a doughnut hole of income that is exempt from Social Security payroll taxes, according to Bill Smith, national director of tax technical services for financial firm CBIZ MHM in Reston, Virginia. For instance, if the law were in effect right now, high-income workers would pay Social Security payroll taxes on the first $168,600 of their income, no Social Security tax on income from $168,601 to $249,999 and then the tax would be assessed for income in excess of $250,000.
Those extra payroll taxes would help prop up the Social Security trust fund while the bill’s other provision — eliminating the federal income tax on benefits — could put money back into the pockets of older Americans.
“The name (You Earned It, You Keep It) might be a little misleading to some,” says Michele Frank, associate professor of accountancy at Miami University in Oxford, Ohio. She notes that because of current income thresholds, only about 40% of Social Security beneficiaries see a portion of their benefits taxed. “It’s not like everyone is going to get a big tax break,” she says.
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Extending Solvency of Social Security Trust Fund
As proposed, the You Earned It, You Keep It Act would allow Social Security to keep making all scheduled payments in full through 2054, according to an analysis by the Office of the Chief Actuary in the Social Security Administration. After that point, Social Security would only be able to pay 91% of owed benefits.
“Arithmetic is going to catch up with this,” Walters says. While the act extends the solvency of the trust fund, he thinks any permanent solution will have to involve either pushing back the full retirement age or reducing benefits.
Walters notes that the bill will also require transfers from the general fund to the Social Security trust funds to make up for any loss of revenue from the elimination of taxes on Social Security benefits. Still, the analysis found the bill’s provisions could be expected to reduce federal debt by $8.9 trillion over a 75-year period.
“I don’t think the government is ever going to let Social Security fail,” Smith says. However, he notes there are still many Republicans from the Ronald Reagan era who remember when the tax on benefits was implemented in 1984 as a way of addressing a shortfall in the Social Security system. They may not be likely to support its repeal.
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Skepticism About the Bill’s Chance of Passage
Currently, the You Earned It, You Keep It Act is awaiting action in the House Committee on Ways and Means. It has also been referred to the House Committee on Energy and Commerce for consideration.
“It didn’t have bipartisan sponsorship, which makes for an uphill struggle in the house,” Smith says. All nine co-sponsors of the bill are Democratic members of the House.
“I think, overall, it’s a good place to start a conversation,” Walters says, adding that it would be better for Congress to address the looming Social Security shortfall sooner rather than later. “The longer we wait, the larger the reforms.”
However, this particular proposal might not be the final solution. “I think it’s a very politically touchy issue,” Frank says.
One complication, she notes, is that it would break President Joe Biden’s pledge not to raise taxes on people earning less than $400,000. As written, it would raise Social Security payroll taxes for those making more than $250,000 per year.
With it being an election year, it seems unlikely that any major reform to Social Security will pass in 2024. However, the clock is ticking, and if legislators can’t come to a consensus soon, retirees may be looking at a reduction in benefits within the next 10 years.
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What to Know About the Bill to Repeal Social Security Taxes originally appeared on usnews.com
