With rising costs of living and budget shortfalls facing many states, some policymakers have proposed implementing a state-level social security tax to boost revenue. A state social security tax would apply to wages and self-employment income, mirroring the existing federal Social Security tax.
Proponents argue that a modest additional tax could generate significant funding for pressing needs like education, infrastructure, and healthcare. However, opponents counter that adding to the existing tax burden would harm economic growth and competitiveness.
An Overview of Social Security Benefits
Social Security benefits provide monthly income for eligible workers and their dependents. The Social Security program was established in 1935 to provide income for older Americans, but today, it also provides benefits for the disabled and survivors of worker place injuries.
According to the Social Security Administration (SSA), Social Security benefits make up about 38% of income for elderly Americans. For many retirees, Social Security forms the foundation of their retirement income. Benefits are based on an individual’s lifetime earnings and the age at which they start receiving benefits.
States Tax Social Security Benefits
While the majority of states do not tax Social Security benefits, some states do. As of 2024, 10 states will tax Social Security benefits: Colorado, Connecticut, Kansas, Minnesota, Montana, New Mexico, Rhode Island, Utah, Vermont, and West Virginia. However, some of these states provide certain exemptions based on income level or age.
Retirees who live in states that do not tax Social Security benefits avoid paying state income taxes on their benefits, which can amount to thousands of dollars per year in savings. The rules surrounding Social Security benefit taxation at the state level can be complex. Retirees should research if their state taxes Social Security benefits and determine if they qualify for any exemptions.
How Social Security Benefits Are Taxed at the Federal Level
Social Security benefits are subject to federal income taxes for some recipients. The federal government began taxing Social Security benefits in 1984 following amendments to the Social Security Act. Under current law, up to 85% of Social Security benefits may be taxable depending on a taxpayer’s income.
Specifically, single filers with a combined income of $25,000 to $34,000 and joint filers with a combined income of $32,000 to $44,000 may have up to 50% of their Social Security benefits taxed. For single filers with income above $34,000 and joint filers above $44,000, up to 85% of benefits may be taxable. Combined income refers to a taxpayer’s adjusted gross income, tax-exempt interest income, and half of their Social Security benefits.
Allocation of Taxed Social Security Benefits
The revenue generated from taxing Social Security benefits is allocated to the Social Security and Medicare trust funds. According to the Social Security Administration, this additional revenue equated to about $37 billion in 2018, or 3.8% of total trust fund income. Taxing benefits was intended to help address Social Security’s long-term funding issues.
However, critics argue this policy disproportionately impacts middle and lower-income beneficiaries. Proposals to scale back or eliminate the taxation of Social Security benefits have been introduced in Congress but have not been enacted.
Not All States Tax Social Security Benefits
As of 2021, only 10 states will continue to tax Social Security benefits in 2024. While most states exempt Social Security benefits from income taxes, these select states have decided to tax a portion of the benefits their residents receive. In these states, retirees can face substantial tax bills on their Social Security income.
The remaining 41 states and Washington D.C. will not tax Social Security benefits in 2024. Retirees in these locations can retain the full benefits without state income taxes reducing their value. For recipients, avoiding state taxation of benefits can mean saving hundreds or even thousands of dollars per year that they can use to pay for essential expenses like housing, food, and medical care.
Strategies to Minimize State Taxes on Social Security
Retirees should explore if their state offers any deductions or exemptions for Social Security income. For example, some states exempt Social Security benefits from taxation for those below a certain income threshold. Other states may allow a portion of Social Security benefits to be deducted.
Retirees should research their state’s tax code to determine if they qualify for any deductions or exemptions for retirees to generate other sources of retirement income that their state does not tax. Some states do not tax retirement account distributions, pension income, or interest income.
The Future of Social Security Benefit Taxation
According to various analyses, Social Security provides nearly all the income for approximately one-seventh retirees in the United States. However, these benefits are not always exempt from federal taxation. Taxation of Social Security began in 1984 following the enactment of amendments signed into law by President Reagan.
Under this law, up to 50% of Social Security benefits could be added to taxable income if a taxpayer’s total income surpassed certain thresholds. Some states levy their income taxes on benefits to exacerbate financial difficulties for retirees relying on Social Security.
Individual Impact on Retirees
Retirees rely heavily on Social Security benefits as a source of income, with approximately 14% depending almost entirely on these benefits to meet their basic needs, according to an analysis by AARP.
However, these benefits are not always exempt from taxes. Since 1984, up to 50% of Social Security benefits could be considered taxable income if the taxpayer’s total income surpassed certain thresholds.
States Have Autonomy
State-level taxation of Social Security benefits creates disparities across the country. While the federal government sets a threshold for taxing benefits, states have autonomy in determining additional taxation policies. Understanding federal and state taxation interplay helps beneficiaries optimize their financial planning.
With Social Security’s long-term funding shortfalls, taxation will likely remain part of balancing revenues and expenditures. However, the inconsistent state-by-state approaches highlight difficulties crafting uniform nationwide policies for the program.
To Tax or Not to Tax
State taxation of social security benefits is a complex issue with valid arguments. Proponents believe it helps states generate needed revenue progressively. Opponents argue it places an unfair burden on retirees. There are also differences in how states apply taxes, with some exempting lower-income residents.
As debates continue over the rising costs of state services and tax burdens, this issue will likely remain politically contentious. Each state must ultimately balance fiscal realities and perceived fairness to its citizens. Further analysis and open discussion of the nuances around social security taxes can help lead to balanced, just policies.
