Taxing Retirees & Taxing an Inheritance

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Dear Readers,
First of all, I'd like to extend warm wishes you all this Thanksgiving holiday.

Like most of you, I will be spending it with family. And I am exceedingly grateful for this. I am also very grateful for the country we live in. It is, by no means, perfect. But it is, in my opinion, the best system human beings have come up with so far. I am especially thankful for the freedoms which we all too-often take for granted, such as the equal treatment of women.

I am also mindful of those who are not going to be spending this Thanksgiving with a loved one because that person was either lost in the horrendous terrorist attacks of Sept. 11, or are on military duty, ensuring that the rest of us can live, love, work and worship as we choose.

Despite the tragedies and the separations, this year we all have a lot to be thankful for.


Hi,Gail —

Has the rate of taxation on Social Security benefits changed with the new tax law?

It was 85%, however, there was a bill in the House that would have reduced it to 50% after you have reached a certain level of income.



Dear Mel,

Sorry, but the 2001 Tax Act did not touch the section of the tax code which covers taxation of Social Security.

However, you bring up a common confusion: the percentages you mention are not the RATE at which your Social Security income is taxed they refer to HOW MUCH of it is subject to tax.

A retiree's Social Security benefits are taxed only if their income exceeds certain thresholds. To see where you stand, start with your Adjusted Gross Income (for 2001, it is found on line #33 of form 1040). You will then have to add back some deductions you were allowed to take, such as income from foreign sources and student loan interest. This gives you your "Modified" Adjusted Gross Income (MAGI).

But you can't stop there. The next thing you need to do is add back HALF of any tax-exempt income you received that year, such as from municipal bonds. This gives you something called your "provisional" income. Now you've arrived at the number you're looking for.

If your provisional income falls into the ranges below, then you may have to add as much as 50% or 85% of your Social Security OR to your regular income for income tax purposes.   

It's actually a bit more involved than this, but the IRS has a one-page worksheet that walks you through the whole calculation. You can access it on the Internal Revenue Service web site: Go to the very bottom of the home page and click on "Forms and Publications." When that page comes up, type the following in the "Search" box: "1040 instructions for 2001." This will bring up the entire brochure. The worksheet you want is on page 26.

What really gripes me about this tax is that the income limits have never been adjusted for inflation! The "50%" threshold was set back in 1983; the "85%" threshold came out ten years later. As a result, many more retirees are paying tax on their Social Security than ever before. But, Mel, at least now you now know the "rate" isn't as high as 85%.

Hope this helps,



I am interested in finding out if the new Tax Relief Act of 2001 affected the inheritance tax laws. I am a beneficiary of my deceased grandfather's trust.

Once his wife passes on, I will receive my portion of the trust. As it stands now, my inheritance will be taxed 55%, then another 55% (something about a generation skipping tax) before I receive the final sum. Thank you for your insight.



Dear Ryan,

Good news! First of all, inherited assets are taxed based on who receives them. For instance, nothing that passed to your grandfather's wife no matter how much he left her is subject to estate tax. That's because you can leave your spouse an unlimited amount of property estate tax-free.

Only assets that pass to people other than a spouse are subject to estate tax and then, only if the size of the deceased's estate exceeds certain limits.

There are two types of estate taxes, depending upon who is the recipient of the property. If an asset is inherited by someone in the next generation say, a son or daughter then the standard estate tax rates apply.

On the other hand, if the asset skips the next generation and passes directly to a grandchild, then the "Generation Skipping Transfer Tax" is used instead. In other words, the property you eventually receive from your grandfather's estate will not be taxed twice- once at regular estate tax rates and again at Generation Skipping Transfer Tax (GSTT) rates. It will only be subject to the GSTT.

More good news! The Generation Skipping Transfer Tax is going down. That's because the GSTT is always equal to the highest estate tax rate. The 2001 Tax Act cuts the top estate tax rate from 55% to 50% next year. It will continue to decline until the estate tax itself is completely eliminated in 2010. And, yep, this means the Generation Skipping Transfer Tax will decline until it follows the estate tax into oblivion.

So, taxes will take a much smaller bite out of your inheritance than you thought.



If you have a question for Gail Buckner and the Your $ Matters column, send them to along with your name and phone number.

The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.