Do you suddenly wish you lived in New Mexico? Legislators there are considering proposals to do away with all state taxes on Social Security income.
That's a welcome possibility for taxpayers in the Land of Enchantment. It's especially welcome now, as the Internal Revenue Service has begun to accept returns for 2021 nationwide. This start to the tax season sparks an annual boom in taxpayers asking, "Do I pay tax on my Social Security income?"
After all, who wants less net income? It's hard enough to generate sufficient retirement income. Many taxpayers find it especially galling that a key source of income for paying expenses during retirement is taxed. And that's the case even though they've stopped working.
In addition, many taxpayers view Social Security money as a benefit they've earned through decades of hard work. They see it as money they've set aside through payroll tax payments. Where's the justice in having the same government claw back some of it through taxes?
No matter where you stand on the philosophical and political science points behind that debate, there's the hard, cold, pragmatic question: Is that income taxed, or is it not?
Social Security Income: Where It Is Not Taxed
The answer depends on where you live. Thirty-seven states plus the District of Columbia do not tax income at all, or they do not include Social Security benefits in their calculations for taxable income, according to the Tax Foundation.
These are the states that levy no income tax:
- Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington and Wyoming.
And these states do not include Social Security benefits in their calculations of taxable income:
- Alabama, Arizona, Arkansas, California, Delaware, District of Columbia, Georgia, Hawaii, Idaho, Illinois, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Massachusetts, Michigan, Mississippi, New Hampshire, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, Virginia and Wisconsin.
Tax Breaks Based On Age, Income
In addition, 13 states reduce taxes on various types of income, which can include Social Security benefits, based on things like age or income level.
New Mexico is one of those 13 states. It basically includes Social Security benefits in taxable income. But the state offers a deduction that cuts tax liability on all retirement income, including Social Security benefits. Legislators in that state are wrestling with whether they can afford to totally stop taxing Social Security income.
Additional states that offer a tax break directly or indirectly on Social Security benefits based on factors like age or income are Utah, Colorado, Connecticut, Kansas, Minnesota, Missouri, Montana, Nebraska, North Dakota, Rhode Island, Vermont and West Virginia.
Montana doesn't exempt a portion of Social Security benefits directly because of age or income, says Heather Schreiber, founder of HLS Retirement Consulting. "However, the portion that is reportable as federally income taxable could be reduced by state exemptions based on age and income for other sources of income like disability or retirement income," she said. Exemptions of other types of income can "cause Social Security benefits that are reported as taxable on the state return to be less than what is reported on the federal return."
No Tax Changes From 2021
No state has changed its treatment of Social Security income since last year, says Jared Walczak, vice president of state projects for the nonpartisan Tax Foundation, an independent tax policy research organization.
"As for rates, Missouri is in the process of reducing its individual income tax rates," Walczak said. "And while they haven't confirmed this yet, they are likely to trigger a reduction of the top rate to 5.3% for this year. Nebraska is reducing its top rate to 7.5% above $100,000 in income, which will be relevant because only single filers with less than $43,000 in adjusted gross income ($58,000 married filing jointly) can subtract Social Security income. All other rates in these states remain identical to last year."
How Much The IRS Taxes Social Security Benefits?
And what about the federal level? Social Security benefits generally are taxable by the IRS. Still, your benefits are hit with less tax or zero tax if your income is low enough.
How much if any of your Social Security benefits are taxable depends on how high what the IRS calls your combined income is, Schreiber says.
Your benefits are totally free from federal income tax if you file as an individual and your combined income is less than $25,000.
Combined income is the sum of your modified adjusted gross income (MAGI) plus 50% of your annual social security benefits. MAGI is your adjusted gross income (AGI) minus Social Security benefits plus tax exempt nontaxable interest.
Your Social Security benefits are also free from federal income tax if you're a married joint filer with less than $32,000 of combined income.
Uncle Sam's Claim On Social Security
If your combined income is above those thresholds, your Social Security benefits are typically taxable. The limits on the tax mainly benefit taxpayers whose overall income is relatively modest.
There are two levels of taxation.
According to ssa.gov, you'll pay federal income tax on up to 50% of your Social Security benefits if you:
- File a return as an individual and your combined income is between $25,000 and $34,000.
- File a joint return and you and your spouse have combined income between $32,000 and $44,000.
You'll pay income tax on up to 85% of your benefits if you:
- File as an individual and your combined income is more than $34,000.
- File a joint-married return and you and your spouse have combined income that is more than $44,000.
Want to know your tax brackets for 2021 and 2022? Read this IBD report.
Follow Paul Katzeff on Twitter at @IBD_PKatzeff for tips about retirement planning and active mutual fund managers who consistently outperform the market.
