Despite the new tax rate reductions of growth and employment Tax Relief Reconciliation Act of 2003, the top marginal tax bracket for many retirees is a huge 46.3%. Why? Because Social Security benefits subject to income tax. Those affected are Social Security recipients who have the fortune (misfortune?) To be subject to both income bracket of 25% tax rate and include 85% for social security benefits.

Here's how it works. First, you must understand how Social Security benefits are taxed. The formula for income tax begins with the calculation of total income. For all practical purposes, total income equals gross income (excluding social security), plus municipal income, and half the taxpayer's social security benefits.

So far, so good. If the income of a married couple is under $ 32,000 ($ 25,000 for a single taxpayer), Social Security benefits are not taxable. If your combined income is between $ 32,000 and $ 44,000 (or $ 25,000 and $ 34,000 for a single person), taxable social security is equal to less than half of social security benefits or half the difference between income total and $ 32,000 ($ 25,000 if single). So far, not too complicated.

This is where the real fun begins. If the total income of the taxpayer 'is more than $ 44,000 ($ 34,000 if single), taxable social security is the same: the lower of (1) 85% of the benefit, or (2) the sum of 85% of total income over $ 44,000 ($ 34,000 if single) plus the lesser of $ 6,000 ($ 4,500 if single) or the amount of social security tax under the old rules. Nobody said created new tax laws to tax simplification.

Here's how you get with the 46.3% bracket. To illustrate an increase in the marginal, it must calculate the taxable income. taxable income, as we all know, is net of allowable deductions and exemptions. The standard deduction (which many pensioners credit), personal exemptions and tax brackets are adjusted annually for inflation.

Suppose Hank more than 65 years, individual files, use the standard deduction in 2006 and has total gross income (excluding Social Security) $ 39,000 to $ 21,900 and receives Social Security benefits. This makes his income $ 49,950 (39,000 + (21,900 x 0.5)). Threshold is exceeded, in a passive way Social Security is equal to the lesser of (a) $ 18,615 (85% of $ 21,900), or (2) the sum of $ 13,558 (($ 49.950 - $ 34.000) x 85%) and $ 4,500. Since $ 18,058 is less than $ 18,615, the taxable amount of his social security benefits is equal to $ 18,058.

This makes his last gross income $ 57,058 ($ 39,000 plus $ 18,058). After taking his 2006 standard deduction of $ 6,400 ($ 5,150 + $ 1,250 for age 65 years) and a personal exemption of $ 3,300, his taxable income is $ 47,358. Which puts him in 25% marginal tax bracket. If the income of Hank goes from $ 10 of taxable income will pay $ 2.50 in taxes on that $ 10 plus $ 2.13 in taxes on the additional cost of $ 8.50 to social security benefits become taxable. Combine $ 2.50 and $ 2.13 and you get a fee of $ 4.63, or 46.5% to $ 10 swing in taxable income. Bingo ... a 46.3% marginal bracket.

Check with your financial advisor or tax advisor on how changes in your investment and income can affect your overall tax picture.