Seniors Get Mugged by the Tax Code

(MoneyWatch) 
Two-thirds of American grandparents have provided financial assistance to their grandkids in the past five years and the recession has got them providing more than ever, according to a recent survey.

The just-released MetLife Quick Poll found that grandparents were ponying up an average of $8,661, or some $370 billion cumulatively. Outside of "general financial support," the most common reason that grandma and grandpa provide cash is to finance education.

Here's the odd thing: If a middle-income parent pays to send his or her child to college, they get a tax deduction or credit for it. And those write-offs have become increasingly lucrative in recent years, now topping out at about $2,500 in dollar-for-dollar breaks. When the grandparents pay the same bills, they get nothing unless the grandchild is actually living with them and can be claimed as a dependent.

The tax code also discriminates against the grandparents when determining how much of their Social Security income is taxable. Back in 1993, when the trend was to boost taxes on the rich, seniors were defined as rich enough to get hit by higher taxes when they earned a mere $34,000 single and $44,000 as a married couple. Some sources of normally tax-free income, such as the interest earned on municipal bonds, were factored into that calculation too. So, a middle-income senior getting a portion of his income from Social Security and a portion from municipal bonds is going to be taxed at a higher marginal rate than a non-retiree with municipal bond income. The Bush Administration, which largely reversed the tax-the-rich policy for the general population, did nothing to alleviate this additional tax on seniors.

It's worth mentioning that if you're not old enough to get Social Security, the tax code doesn't start to slam you for being too rich until you earn about $110,000--nearly three times more than what it takes to be "rich" when you're a retiree.

So why are seniors kicked by the tax code? Experts can only guess. There's a theory that seniors are sitting on vast pots of cash and only pulling out the amont of money they need each year, which would indicate that they're richer than they appear on paper.

However, the MetLife survey reflects a different reality. Almost a quarter of the grandparents who are providing financial support worry that they're hurting their own financial stability in the process. And yet these financially-strained grandparents say they're providing more assistance than before.

What do you think? Are old folks rich enough to deserve a tax-drubbing, or are they getting mugged by the tax code?