Social Security Taxation and Allowable Deductions

A reader from Ohio asks for clarification regarding 2021 Social Security taxation and allowable deductions.

Today I sat down to do my 2021 income taxes, and I think I found a change in the formula for calculating taxable Social Security benefits. Last year (2020 tax year), for taxpayers electing the standard deduction, the IRS worksheet for calculating how much Social Security was subject to federal income tax allowed the $300 deduction for charitable contributions to be subtracted from income subject to Social Security taxation. This year (2021 tax year), this $300 line-item deduction was omitted from the small print of the Social Security Benefits Worksheet directions. There is no notification of the change anywhere, even though it results in up to $255 more of Social Security benefits being taxed. I cannot find anywhere in Schedule 1 (adjustments to income) where that last year’s deduction can be recouped. Am I missing something, or has Uncle Sam pulled a fast one? The $300 deduction is still allowed from total income, just not from income subject to Social Security. But that deduction is only worth $45 if your AGI is increased by $255 before you can subtract it.

Let’s step back for a moment and talk about this $300 (and now potentially $600 for married filing jointly) bonus deduction. It is available for those who contribute to charity but no longer itemize their deductions. Between using Schedule A (where we itemize) or taking the standard deduction, we usually default to the one that’s the higher number. But more people are now taking the standard deduction because the limits were increased.

So what Congress did as part of the CARES Act in 2020 was to say, “If you’re taking the standard deduction and you’re doing odd charity, we will allow you to take a maximum $300-per-tax-return deduction.” What’s critical is that it was calculated as a deduction to arrive at AGI. So it was above the AGI calculation on your tax return.

This year they extended the charitable deduction – and actually made it $300 single and $600 if you are married filing jointly. But they moved it to below the AGI line, so now it’s a deduction “from” AGI instead of being “towards” AGI.

So, in your case, it’s not that the Social Security calculation changed your AGI. Instead, changing where the deduction occurs has impacted your Social Security calculation. The taxability of your Social Security was affected because the deduction did not lower your AGI this year like it did last year.

So, in the grand scheme of things, the deduction is still granted. You’re still taking advantage of the $300-to-$600 carve-out that Congress allowed for charitable giving for those using the standard deduction. But “where” you deduct it has changed how much of your Social Security gets sucked into taxable status.

Everyone still gets a benefit: either $300 or $600 of your income will not be taxed if you’re eligible for the deduction. So that’s still good.

But the opportunity to decrease your AGI by that bonus charitable deduction has been lost. And it is impacting you because you happen to be within the range of Social Security that is neither tax-free nor taxed at the full 85%. (At either end of the extreme of taxability of Social Security, the change would not have made a difference.)

Losing the option to lower your AGI is causing the calculation of the taxability of your Social Security to go up by $255. So, for you, the deduction will save you a few income tax dollars, but it’s almost a wash.

However, there’s another issue to look out for: IRMAA. That, too, is based on your AGI, modified by a couple of numbers. Maybe last year, you were able to get your AGI or MAGI down just a hair below a cliff. This year, the opportunity is not there. So if that’s part of this year’s IRMAA planning, and you’re too close to a cliff, losing that deduction could throw you into the next IRMAA tier for this year.

In that case, it’s going to be a detriment in a couple of years when you go to see what your Medicare costs are going to be, after the standard 2-year delay.

Like you, we hadn’t heard of any announcements about this change and only saw it when we started looking at the new tax forms. We honestly can’t find any good reason for the change. All we know is that some folks are only noticing it when they land on the wrong end of a calculation and are harmed by the change.