Tax-Exempt Interest Should Be Used in Determining Amount of Taxable Social Security Benefits

UIL 86.01-03

Dear Senator Cornyn:

This letter responds to your inquiry dated July 10, 2009, on behalf of your constituent, * * *. * * * asked about the inclusion of municipal bond tax-exempt interest in determining the amount of his taxable social security benefits.

Gross income may include a portion of social security benefits [section 86(a)(1) of the Internal Revenue Code]. As a general rule, if the only source of a recipient's income is social security benefits, then those benefits are not subject to income tax. However, if in addition to social security benefits the recipient receives other income, then a portion of social security benefits may be taxable. Where the total income exceeds certain amounts, a part of the social security benefits are taxable. This practice assures that lower-income individuals, who rely on their benefits to afford basic necessities, are not taxed on their benefits and that individuals who have substantial taxable income from other sources are taxed on a portion of their benefits.

Taxpayers must calculate their modified adjusted gross income to determine if social security benefits are taxable [section 86(b)(2) of the Internal Revenue Code]. They must include tax-exempt interest in modified adjusted gross income when calculating the amount of taxable social security benefits. Although tax-exempt interest is not itself taxable, it can cause the taxation of additional social security benefits because the interest is added to adjusted gross income to form a larger modified adjusted gross income.

As the Congress explained in the legislative history when it enacted section 86, the law does not affect the exclusion from income for interest on tax-exempt obligations. It merely requires the inclusion of tax-exempt interest in adjusted gross income when determining the amount of taxable social security benefits. [Senate Report No. 98-23, 98^th Congress, 1^st Sess. 25, 27 (1983), 1983-2 Cumulative Bulletin 326, 328].

I hope this information is helpful. If you would like to discuss this further, please contact * * * or me at (* * *) * * *.