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Social Insecurity
While working on the tax return of a single retired, age 65+, woman, I started with the assumption that she'd land in the 15% bracket. With $33,000 in planned IRA distributions for the year (all numbers are based on 2006 taxes), combined standard deduction and exemption of $9700, she'd have $23,300 in taxable income, and a glance at Fairmark will give you a 15% rate with room to convert some money to a Roth, if she wished. Well, I was wrong, so very wrong. She also had $15,000 of Social Security income. Not enough to be rich, but enough income to be trapped in a phantom tax rate of 46.25%. I'm sorry, that's not a typo, Forty Six and a Quarter Percent!! I discovered this by simply adding $1000 to her IRA distribution number on the 2006 tax return software. Instead of a $150 tax increase, I saw $462. I then learned that when half of your Social Security benefits and other income exceed $25,000 ($32,000 if married filing joint), your benefits become taxable. To keep her in the lower phantom marginal rate of 27.5% we took advantage of the 2006-7 law allowing direct charitable donations from IRAs. We will likely do the same this year.