Taxation in the United States covers several areas, including income, property, purchases, capital gains, and estate inheritance. Though often met with disapproval, taxes fund many essential public services used by residents nationwide. Among the forms of taxable income in retirement, Social Security benefits are notably subject to federal and, in some cases, state taxation.
For retirees, it is crucial to understand whether their state taxes Social Security payments, as this can significantly impact their net income. Fortunately, most Americans receive Social Security benefits free from state income tax due to specific state policies. However, millions still encounter taxation on these benefits depending on their state of residence.
States Without Social Security Benefit Taxes
Currently, 42 states and the District of Columbia do not impose state income taxes on Social Security benefits. These states are:
- Alabama
- Alaska
- Arizona
- Arkansas
- California
- Delaware
- Florida
- Georgia
- Hawaii
- Idaho
- Illinois
- Indiana
- Iowa
- Kansas
- Kentucky
- Louisiana
- Maine
- Maryland
- Massachusetts
- Michigan
- Mississippi
- Missouri
- Nebraska
- Nevada
- New Hampshire
- New Jersey
- New York
- North Carolina
- North Dakota
- Ohio
- Oklahoma
- Oregon
- Pennsylvania
- South Carolina
- South Dakota
- Tennessee
- Texas
- Virginia
- West Virginia
- Washington
- Wisconsin
- Wyoming
Among these, West Virginia recently joined the exemption list this year by eliminating its state tax on Social Security benefits. States that eliminate this tax often aim to attract and retain retirees, who contribute to the economy through their spending patterns.
States That Continue to Tax Social Security Benefits
In contrast, eight states currently impose some level of taxation on Social Security benefits. These states include:
- Colorado
- Connecticut
- Minnesota
- Montana
- New Mexico
- Rhode Island
- Utah
- Vermont
Recent years have seen some states, such as Missouri, Nebraska, and Kansas, phase out their taxation of Social Security benefits. While no assurances exist that other states will follow, such changes highlight a trend where tax policies evolve to support retirees' financial well-being.
Understanding Federal Taxation of Social Security Income
Regardless of state rules, retirees must consider potential federal taxes on their Social Security benefits. The Internal Revenue Service calculates federal tax obligations based on "combined income," a measure incorporating several components:
- Adjusted gross income (AGI)
- One-half of the annual Social Security benefits
- Tax-exempt interest income, such as from Treasury or municipal bonds
For illustration, consider a retiree with an AGI of $15,000, receiving $30,000 in Social Security benefits annually, along with $1,000 in tax-exempt interest. Their combined income would be $31,000, computed as $15,000 (AGI) + $15,000 (half of Social Security benefits) + $1,000 (tax-exempt interest).
The IRS applies the following thresholds to assess the portion of Social Security income subject to federal tax, differentiated by filing status:
| Filing Status | Combined Income Threshold for 0% Taxable Benefits | 50% Taxable Benefits Threshold | 85% Taxable Benefits Threshold |
|---|---|---|---|
| Single | Less than $25,000 | $25,000 to $34,000 | More than $34,000 |
| Married, Filing Jointly | Less than $32,000 | $32,000 to $44,000 | More than $44,000 |
It is important to clarify that the stated percentages indicate how much of the Social Security benefits become taxable, not the actual tax rate applied. That taxable portion is added to other taxable income and then subjected to the individual's ordinary income tax rate.
For example, if the individual in the previous example files taxes as single, up to $15,000 of their Social Security benefits may be taxable. Assuming a 12% tax bracket, their federal tax liability on these benefits could be as much as $1,800 annually, which is favorable compared to higher potential tax burdens.
Considerations for Retirees
Retirees should carefully review both their state and federal tax obligations related to Social Security benefits to plan effectively for retirement income. Awareness of these tax policies can aid in making informed decisions about residency and financial planning.