Municipal Bond Forum
Provisional income affects tax on Social Security
Q
I’ve been buying municipal bonds from FMSbonds for the past few years. I was expecting no federal income tax on any of them and no state tax on the Arizona and Puerto Rico bonds. But I read recently that tax-free income from muni bonds causes more of social security income to be taxed. Will I end up with less after-tax income than I planned for because all of the muni income is not tax exempt from federal taxes (none of my bonds are AMT)? Does it affect the tax equivalent yield I use in my spreadsheet?
A
James A. Klotz responds:
You are correct: Taxpayers do get taxed on a portion of their social security benefits when provisional income (as defined by the IRS) exceeds certain levels. Provisional income includes adjusted gross income, tax free income, as well as a specified percentage of the social security benefit itself. For married taxpayers (filing jointly) the base amount is $32,000, over which a portion of the benefit becomes taxable.
However, the income from a taxable income producing investment would add to provisional income as well, and the income on that investment itself would also be subject to income taxes. If anything, the presumably higher pre-tax income on a taxable investment would make more of your benefit taxable.
Accordingly, there should be no affect on the tax equivalent yield that you use in your spreadsheet.
Start here.
Do you have specific criteria for bonds you’re looking for? Let us know and we’ll e-mail you bonds that fit your needs. There is no charge for this service.
The responses provided in this forum are meant to address specific questions posed by investors about their municipal bonds and to provide market insight for our general audience. Please note, your investments, objectives, results and experience may differ significantly. Our answers and any potential strategies discussed should not be construed as a solicitation to buy nor sell any security or investment product. All investing entails risk.