Hamill: What the new senior deduction really means

Today, I will discuss the new “senior deduction.” But I also must address a broader issue. This is to, I hope, eliminate confusion about the senior deduction.

Leading up to the 2024 election, President Donald Trump made several statements about tax policy in a future administration.

These statements included no tax on tips, no tax on overtime and no tax on Social Security benefits.

A tax bill signed into law on July 4 included a provision for no tax on tips and another for no tax on overtime.

There was no provision for no tax on Social Security. There was a new “senior deduction.” 

In the immediate passage of the new law, many claims were made about its super-duper benefits. One was that the law included no tax on Social Security.

The senior deduction is $6,000 for anyone who reached age 65 by the end of 2025. A married couple, both meeting the age requirements, can deduct $12,000.

This deduction begins to decline at $75,000 of income ($150,000 married) and is lost when income reaches $175,000 ($250,000 married).

If you were born in 1960, you turned 65 in 2025. Your Social Security “full retirement age” is 67.

You get 100% of your benefits if you wait until age 67 to start receiving benefits. If you start before age 67, you receive reduced benefits.

You could wait until age 70 and get more than the full benefits. Whatever age you select starts an “annuity” payout based on Social Security benefit rules.

The senior deduction reduces taxable income even if you do not itemize your deductions. It is not tied to any particular source of income.

Let’s say that you turn 65 in 2025. You are waiting until age 67 to start Social Security. You get the $6,000 senior deduction to reduce taxable income. 

Let’s say that you wait until age 70 (2030 tax year) to start Social Security. You get the senior deduction in 2025 through 2028 tax years.

The senior deduction is scheduled to end in 2028. If the 1960 baby waits until 2030 to start benefits, he still gets the deduction from 2025 to 2028. 

Since that person had Social Security benefits before 2029, he did not reduce the tax effect of Social Security benefits.

The basic point is that the senior deduction has nothing to do with Social Security. It is not tied to any particular type of income.

Should we have no tax on Social Security? We didn’t until 1984. Social Security law initially treated benefits as a “gratuity” received from the government. 

These gratuities were exempt from tax. In 1984, Social Security needed a funding boost. The law was changed to make some benefits taxable.

To protect “lower income” beneficiaries, an income threshold was established to continue to allow no tax on Social Security.

Those above this threshold could have 50% of the benefits included in taxable income.

In 1993, two new income thresholds were established. If below the threshold, no Social Security benefits would be taxed.

If income passed the first threshold, 50% of benefits would be taxed. If income passed the second threshold, 85% of benefits would be taxed.

The lower income thresholds, from 1984 and 1993, were arbitrary. They were intended to meet a policy objective of protecting “low-income” beneficiaries.

The 1993 highest threshold was based on actuarial calculations. Social Security benefits resemble commercial annuities.

If you receive payments from an annuity contract, you may exclude a certain percentage of the payments from taxable income.

The percentage is based on how much you paid to get the annuity. It allows you to recover your investment tax-free and pay tax only on earnings.

Social Security benefits are funded from three sources; your contributions, which are after-tax, employer contributions, which are pre-tax, and earnings on those amounts.

In 1984, it was estimated that only 17% of all benefits came from your after-tax contributions. That could justify taxing 83% of your benefits.

The math has changed as contributions have increased, but the idea of taxing Social Security is that it should be like other annuities. 

One could argue with the 50% and 85% figures, but there is logic to taxing Social Security.

Jim Hamill is the director of tax practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at jimhamill@rhcocpa.com.