Social Security is a critical stream of income for retirees, providing stability after years of paycheck contributions. The federal government taxes Social Security benefits to a certain extent, but each state has a different set of regulations.
As tax preparers and advisors, you need to be aware of the taxability and nontaxability of Social Security benefits to file accurate tax returns and effectively advise your clients on planning strategies. In this article, we’ll cover the federal tax treatment of Social Security benefits and explore the tax implications in each state.
Federal Tax Treatment of Social Security
Social Security is taxable up to 85% based on the taxpayer’s combined income. The taxable percentage is assessed on a marginal scale based on the taxpayer’s filing status. Individual taxpayers will be required to pay taxes on 50% of the benefits if their combined income is between $25,000 and $34,000. This threshold is adjusted to between $32,000 and $44,000 for joint filers. Once $34,000 or $44,000 is exceeded for individual and joint filers, respectively, 85% of Social Security benefits will be taxable.
The Social Security Administration defines combined income as a taxpayer’s adjusted gross income (AGI) plus tax-exempt interest and half of their Social Security benefits. For example, let’s say a single taxpayer’s AGI is $50,000, tax-exempt income is $10,000, and total Social Security benefits are $40,000. The combined income would be $80,000 ($50,000 + $10,000 + ($40,000 × 50%)). This combined income level exceeding $34,000 would warrant 85% taxation on their Social Security benefits.
State Tax Treatment of Social Security
State taxation of Social Security benefits does not conform to the federal tax treatment. Most states, 39 to be exact, exclude Social Security benefits from taxable income. However, as of 2023, there are 11 states that don’t allow a full exclusion or deduction for benefits paid, including:
- Colorado – Subtraction allowed up to $20,000 for taxpayers who are 55 years of age or older, but younger than 65 years old (taxpayers who are 65 years of age or older can subtract the full amount of social security benefits on their Colorado returns).
- Connecticut – 100% subtraction if AGI is under $100,000 for married filing joint, head of household, and qualifying widow(er) taxpayers. The AGI threshold is reduced to $75,000 for single filers. Taxpayers over these thresholds receive a deduction so that no more than 25% of their benefits are taxable in Connecticut.
- Kansas – Subtraction from federal taxable income allowed if federal AGI is under $75,000, regardless of filing status.
- Minnesota – Maximum subtraction of $2,920 for married filing separate taxpayers, $4,560 for single and head of household filers, and $5,840 for joint filers. Taxpayers must reduce the subtraction by 20% of provisional income over $44,315 for married filing separate taxpayers, $69,250 for single and head of household filers, and $88,630 for joint filers.
- Missouri – Subtraction of Social Security benefits is allowed if Missouri AGI is under $100,000 for joint filers and $85,000 for all other filing statuses. Once the AGI threshold is met, there is a dollar-for-dollar phase-out of the subtraction. Beginning in 2024, Missouri will not tax Social Security benefits.
- Montana – Montana taxable benefits in excess of federal taxable benefits are required to be added back to income. If federal taxable benefits exceed Montana taxable benefits, taxpayers can subtract the difference from taxable income. The social security benefits schedule on Page 6 of Form 2 works through the calculation of Montana taxable social security benefits.
- Nebraska – Nebraska is beginning to phase-out the taxation of Social Security benefits. For the 2023 tax year, taxpayers can take a 60% deduction on social security benefits included in federal AGI. This amount increases to 80% for the 2024 tax year and 100% for years thereafter.
- New Mexico – Complete exemption allowed for single taxpayers earning less than $100,000, joint taxpayers earning less than $150,000, and married filing separate taxpayers earning under $75,000 in income.
- Rhode Island – Subtraction allowed if federal AGI is under $95,800 for single and head of household filers, and $119,750 for joint filers. Taxpayers must have reached full retirement age to qualify.
- Utah – Taxpayers can claim a credit for federal taxable benefits multiplied by the Utah individual income tax rate, reduced by 2.50% for each dollar modified AGI exceeds $31,000 for married filing separate taxpayers, $37,000for single taxpayers, and $62,000 for all other filing statuses.
- Vermont – Subtraction allowed for federal taxable amount if AGI is below $65,000 for joint filers and $50,000 for all other filers. Subtraction begins to phase out if AGI exceeds these thresholds. The exemption fully phases out once joint filers reach an AGI of $75,000 and all other filing statuses reach an AGI of $60,000.
States can adjust their taxation policies surrounding Social Security benefits based on a variety of factors, including budgetary needs and residency goals. If a state is looking to attract more retirees, they might choose to bypass taxation of Social Security income, a revenue stream that most retirees rely on.
In many of these 11 states, there are AGI limits that influence the allowable subtraction. Each year, these limits are indexed for inflation, making it important to stay up-to-date on applicable thresholds when filing state tax returns. Here is a summarized list of which states tax and do not tax Social Security benefits.
States That Tax Social Security
States That Don’t Tax Social Security
What Does This Mean for Your Clients?
Tax preparers need to be aware of the impact of Social Security benefits when filing state returns and tax planning for the upcoming year. Neglecting to properly subtract Social Security from AGI can result in overpaying on state income taxes. Additionally, suggesting the proper estimated tax payments and planning strategies relies on understanding how Social Security is taxed in each state.
The taxation of Social Security benefits isn’t the only component you will need to understand when filing tax returns this upcoming season. This concept and more will be discussed at the 2023 Fall Tax School. And be sure to check out our new self-study course: Tax Issues Facing Aging Clients, which goes into detail on social security benefits.
By Rachel Szeklinski, CPA