Question 23: My mother-in-law just started to receive Railraod Retirement benefits and she's wondering if they are taxable. If they are, should she make quarterly estimated Federal Income Tax deposits to the IRS, and how can she figure how much to pay?
Answer: The short answer is "yes," Railroad Retirement benefits are taxable under the Federal income tax laws. But the way they are taxed is very complex and somewhat confusing. After reading my answer, you may want to consult with an accountant experienced in advising retired rail workers, or the IRS.
The Railroad Retirement Board (RRB) should already be withholding income taxes from your mother-in-law's monthly benefits. Of course, she can change the amount of withholding or even cancel it by filing a W-4 form with the RRB. You should contact the local RRB office(See Q&A-9 of this column) to find out how much they are withholding.
One note of caution. She must either have the RRB withhold from her monthly payments or make quarterly estimated tax deposits with the IRS. Failure to do either will result in substantial penalities when she files her Federal 1040 income tax return. Most beneficiaries find it more convienent to have the RRB withhold from their monthly payments.
As I stated above, the actual application of the Federal income tax to Railroad Retirement is very complicated. Most Railroad Retirement benefits consist of two components, or Tiers. Most of Tier 1 is like a Social Security benefit and is taxed in exactly the same way. If your mother-in-law is single and her income exceeds $25,000, 50% of the Social Security amount is taxable. If she is married, then the threshold for joint income of a married couple is $32,000. If the annual income is substanially higher, up to 85% could be taxable.
The remainer of the benefit is treated as a "contributory private pension." IRS applies the socallled "General Rule" to determine the amount that is considered to have come from your mother-in-law's share of payroll taxes over the years and therefore becomes excluded from Federal income tax. The balance is treated as ordinary income and taxed as such.
Like the Social Security Administration and all private pension administrators, the RRB reports all payments to the IRS and issues Form W-2 and 1099R report forms in January of each year for payments made in the preceding year.
You should check to see if her benefits are taxable by her state. A few states, such as Nevada, Texas and Florida, do not have an income tax. Some states, such as Illinois, fully exempt pensions from their state income tax or exempt a portion. Other states fully tax Railroad Retirement and other pension benefits.