Social Security benefits are a crucial source of income for millions of American retirees. However, these benefits are subject to federal tax rules, and in some cases, state taxes as well. The good news is that most states do not tax Social Security benefits.
In fact, 41 states and Washington, D.C. currently do not tax these benefits. This means that retirees in these states can enjoy their Social Security income without worrying about additional state taxes. However, it’s important to note that federal tax rules still apply to everyone, regardless of their state’s specific tax rules.
The IRS uses a formula called “combined income” to determine how much of a retiree’s Social Security benefits are taxable. Combined income includes adjusted gross income (AGI) from all non-Social Security sources, nontaxable interest income, and half of the retiree’s Social Security benefits for the current year.
Federal taxes on Social Security
Once combined income is calculated, the IRS uses specific thresholds to determine how much of the benefits are taxable. For example, if a married couple filing jointly has a combined income of $49,000, up to 85% of their Social Security benefits for the year are eligible to be taxed. This taxable portion is then added to any other income and taxed at the couple’s regular income tax rate.
It’s important to understand that the percentages used in these calculations refer to how much of the benefits are taxable, not the actual tax rate. Many people mistakenly believe that their benefits will be taxed at 85%, but this is not the case. As retirees plan their finances, it’s crucial to keep these tax rules in mind.
While most states offer tax breaks on Social Security benefits, federal taxes can still take a significant bite out of retirement income. By understanding how these taxes work, retirees can make informed decisions and avoid surprises come tax time.
