Tax Treatment of Social Security Benefits
Federal Tax Treatment
During his campaign, President Trump vowed to eliminate the taxation at the federal level of all Social Security benefits. According to the Social Security Administration, only about 40% of its beneficiaries pay federal income tax on their benefits. But I'd be willing to wager that the vast majority of you reading this fall into that group.
That's because taxpayers filing as individuals need only have $25,000 in "combined income", and those filing jointly need only have $32,000 in "combined income", for some portion of their Social Security benefits to be taxed as ordinary income. Above $34,000 in "combined income" for singles and $44,000 for couples, 85% of Social Security benefits are taxable at the federal level.
And to effectively lower these already low hurdles even more, "combined income" is defined as adjusted gross income PLUS non-taxable interest PLUS 50% of the SS benefits. So municipal bond interest, ordinarily tax-free at the federal level, is added back to your AGI for the purposes of determining the tax treatment of Social Security AND half of the SS benefits themselves are included in the calculation to determine if they are, in turn, taxable.
The reason for these really low income thresholds that determine the taxation of Social Security is that they were enacted in 1993 and aren't indexed for inflation despite the fact that earned income has obviously inflated since then and that SS benefits themselves also have a cost-of-living adjustment.
State Tax Treatment
The bright side of the story about Social Security taxation is that the vast majority of states do not tax this income. However, unfortunately again for most of you reading this, Utah is one of the few states that does tax Social Security income. SS tax treatment here at the state level generally mirrors that at the federal level in that a taxpayer's adjusted gross income determines whether their benefits are tax-free, 50% taxable, or 85% taxable, although the applicable income thresholds are a bit more generous in Utah than at the federal level.
Since misery loves company, you may be happy to know that two of our Rocky Mountain neighbors, Colorado and Montana, also tax Social Security benefits, as do Connecticut, Minnesota, New Mexico, Rhode Island, and Vermont.
About the Author
Paul Winter, MBA, CFA, CFP® is a Fee-Only financial advisor and fiduciary in Salt Lake City, UT. His independent wealth management firm, Five Seasons Financial Planning, provides professional portfolio management and objective financial planning services to individuals and families, and to their related entities including trusts, estates, charitable organizations, and small businesses.