Read § 86. It is not an easy read. It is an example of the drafting contortions necessary to accomplish legislative compromise. Section 86 of course is among the Code provisions that require inclusion of certain items in gross income. Section 86 limits the amount of social security benefits that a taxpayer must include in gross income. Taxpayer excludes the remainder.
- Section 86 establishes three levels of so-called “(b)(1)(A) amounts” of income – which we define momentarily.
- This amount will fall into one of three ranges that the Code defines in terms of the taxpayer’s filing status. Each income range is subject to a different set of rules governing
inclusion of social security benefits in taxpayer’s gross income. The three income ranges are the following:
- “(b)(1)(A) amount” of income that is below the statutory “base amount.” “(b)(1)(A) amount” of income that is above the statutory “base amount” but below the statutory “modified base amount.”
- “(b)(1)(A) amount” of income that is above the statutory “modified base amount.”
Rather than try to state the computation rules, we will apply the rules through three problems involving the taxpayer “Joe the Pensioner.” He is single and receives social security benefits. Consider:
- Joe the Pensioner received $20,000 of social security benefits payments last year. In addition, he received $1000 in municipal bond interest that § 103 exempts from his gross income. Joe also did some work for his old employer for which he received $6000. What is Joe’s gross income?
Section 86(a) with deceptive simplicity sets forth rules governing taxpayer inclusion in gross income of social security benefits. Section 86(a) requires computations of various amounts and then comparing them. Hopefully, we can reduce this to a few straight-forward “if ... then” rules. It is best 1 to begin with § 86(b) – the provision that actually defines the “Taxpayers to Whom Subsection (a) applies.”
- Section 86(b)(1)(A)(i) requires that we determine what Joe’s “modified agi” is. That phrase is defined in § 86(b)(2). Joe’s agi at the moment, not counting his social security benefits or tax exempt interest, is $6000. To obtain Joe’s “modified agi,” we do not add his benefits (§ 86(b)(2)(A) (“determined without regard to this section”)) but we do add his tax exempt interest, § 86(b)(2)(B), i.e., $1000. Joe’s modified adjusted gross income is$7000.
- Section 86(b)(1)(A) requires us to add Joe’s modified adjusted gross income plus one-half of his social security benefits. $7000 + $10,000 = $17,000. We will refer to this as the “(b)(1)(A) amount.”
- Subtract the “base amount” from $17,000. “Base amount” is defined for Joe in § 86(c)(1)(A) as $25,000. Joe’s “modified agi” does not exceed this “base amount.”
- Section 86(a)(1)(B) requires us to compute one-half of the excess described in § 86(b)(1)(A). In our case, that will of course be $0.
- § 86(a)(1) requires a comparison: $0 < $10,000.
- Joe must include $0 of his Social Security benefits in his gross income.
Notice that if the base amount exceeds taxpayer’s “modified agi” plus one-half of his/her social security benefits, then there will be no “excess” – a term that appears in § 86(a)(1)(B). We can state the following straight-forward rule.
1. If taxpayer’s “modified agi” plus one-half of his/her social security benefits is less than the statutory “base amount,” none of taxpayer’s social security benefits will be subject to federal income tax.
Now suppose that Joe the Pensioner received $20,000 of social security benefit payments, $1000 in tax exempt interest, and $18,000 of payments for work he did for his old employer.
- Joe’s “modified agi” plus one-half of his social security benefits plus tax exempt interest (i.e., “(b)(1)(A)” amount) equals $29,000. This is more than the statutory “base amount,” i.e.,
$25,000, § 86(c)(1)(A).
- Section 86(b)(1) describes a taxpayer whose “(b)(1)(A) amount” is more than a “modified base amount.” For Joe, that amount is $34,000. § 86(c)(2)(A). Joe’s “(b)(1)(A) amount” does not exceed his “modified base amount,” so § 86(a)(1) applies to him.
- According to § 86(a)(1), Joe must include in his gross income the lesser of one-half of the social security benefits that he received or one-half of the amount by which his “(b)(1)(A)”
amount exceeds his “base amount.”
- The first amount is $10,000. The second amount is $2000.
- Joe must include $2000 of social security benefits in his gross income.
We can now state the second of our straight-forward rules.
2. If taxpayer’s “modified agi” plus one-half of his/her social security benefits is more than the statutory “base amount” but less than the “modified base amount,” taxpayer must include in his/her gross income the lesser of one-half of his/her social security benefits or one-half of the amount by which his/her “modified agi” exceeds the statutory base amount.
Now suppose that Joe the Pensioner received $20,000 of social security benefit payments, $1000 in tax exempt interest, and $30,000 of payments for work he did for his old employer.
- Joe’s “(b)(1)(A) amount” is now $41,000. This is $7000 more than his “modified base amount,” i.e., $34,000, § 86(c)(2)(A). This means that § 86(a)(2) applies rather than § 86(a)(1).
- Section 86(a)(2) requires us to determine two different amounts and to include the lesser in Joe’s gross income.
- The first amount (§ 86(a)(2)(A)) is –
- 85% of the “excess,” i.e., 85% of $7000 – or $5950, PLUS
- the lesser of
- the amount that would be included in Joe’s gross income if our second rule (i.e., § 86(a)(1)) did apply. The lesser of one-half of Joe’s social security bene-fits (i.e., $10,000) or one-half of the excess of Joe’s “(b)(1)(A) amount” over his “base amount” (i.e., ½ of ($41,000 − $25,000) = $8000) is $8000.
- or
- one-half of the difference between Joe’s “base amount” and “modified base amount.” The difference between Joe’s “base amount” and his “modified base amount” is $34,000 − $25,000. One-half of that amount is $4500.
- $4500 < $8000.
- $5940 + $4500 EQUALS $10,440.
- The second amount (§ 86(a)(2)(B)) is –
- 85% of Joe’s social security benefit, i.e., 85% of $20,000 = $17,000.
- $10,440 < $17,000. Joe must include $10,440 in his gross income.
We state the third of our straight-forward rules.
3. If taxpayer’s “modified agi” plus one-half of his/her social security benefits is more than the statutory “adjusted base amount,” taxpayer must include in his/her gross income the lesser of two amounts computed according to two more rules.
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