Understanding How Social Security Is Taxed & Why Your Income Type Matters

As clients approach retirement, one of the most common questions we hear is:

“Will my Social Security be taxed?”

The answer depends on the type & amount of income you receive alongside your benefits. Whether you’re still earning, collecting rent, or realizing capital gains, the way your income interacts with Social Security can have a significant impact on your overall tax picture.

Below, we break down how Social Security taxation really works — & how to plan around it.

1.) The Core Concept: Provisional Income

The IRS doesn’t simply look at your Social Security benefits in isolation. Instead, it calculates something called provisional income, which determines how much of your benefit becomes taxable.

Provisional income = Adjusted Gross Income (AGI)

Tax-exempt interest (e.g., municipal bonds)
50% of your Social Security benefits

This formula means that earned income, passive income, capital gains, & even tax-free bond interest can all increase the portion of your benefits that are taxed.

2.) The Key Thresholds

3.) How Different Income Types Affect Taxation

A. Earned Income (Wages or Self-Employment)

Fully included in AGI & therefore provisional income.
Even modest part-time work can push your benefits into the taxable range.
Example: A retiree earning $40,000 from consulting will likely have 85% of their benefits taxable.

B. Passive Income (Rental or Business Income)

Also counts fully toward AGI.
Real estate investors sometimes see lower AGI because of depreciation deductions, which can reduce how much of their benefits are taxed.

C. Capital Gains (Stocks, Real Estate, or Business Sales)

Count in AGI even if taxed at preferential long-term rates.
A large one-time gain can temporarily push you into the highest Social Security tax zone.
Example: Selling appreciated stock for $100,000 may make 85% of your benefits taxable for that year.

D. Tax-Exempt Interest

Even income from municipal bonds, which is federally tax-free, still counts toward provisional income.

4.) Examples

Example 1 — Lower-Income Single Retiree

Social Security: $20,000

Part-time income: $10,000

Provisional income = $10,000 + (½ × $20,000) = $20,000 → No Social Security tax.

Example 2 — Married Couple with Rentals

Social Security: $40,000

Rental income: $120,000

Provisional income = $120,000 + (½ × $40,000) = $140,000 → Up to 85% taxable.

Example 3 — Retiree with Capital Gains

Social Security: $30,000

Capital gain: $85,000

Provisional income = $85,000 + (½ × $30,000) = $100,000 → Up to 85% taxable this year.

5.) Planning Strategies

Understanding the mechanics is the first step. The next is proactively managing your income sources:

Time your benefits. Delay Social Security until earned income drops or before Required Minimum Distributions begin.
Use Roth conversions. Withdrawals from Roth IRAs don’t count toward provisional income.
Manage capital gains. Spread sales across years or harvest gains before starting benefits.
Leverage depreciation. Real estate investors can reduce taxable passive income through depreciation.
Coordinate withdrawals. Blend distributions from taxable, tax-deferred, & Roth accounts to smooth annual income levels.

6.) The Takeaway

Social Security taxation isn’t just about how much you receive — it’s about what else shows up on your tax return. By understanding how earned income, passive income, & capital gains interact, you can better control when & how much of your benefit is taxed.

At Abbey Street, we help clients navigate this complexity by building integrated tax, retirement, & investment strategies that maximize after-tax income in retirement.

For more guidance on how Social Security fits into your broader financial plan, contact the Abbey Street team.

Learn More

IRS.gov – https://www.irs.gov/faqs/social-security-income

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