Taxing Social Security Benefits

Background

According to estimates, about half of all Social Security beneficiaries owed some income tax on their benefits in 2014. Since 1984, up to 50 percent of Social Security benefits have been subject to federal income tax for those whose modified adjusted gross income (MAGI) exceeds certain thresholds: $25,000 for single people and $32,000 for married couples. MAGI is the sum of adjusted gross income, nontaxable interest income, and one-half of Social Security benefits. The revenue raised is credited to the Social Security trust funds. Some plans to reform Social Security have proposed increasing the percentage of benefits subject to a tax and/or lowering the tax thresholds.

Since 1994, up to 85 percent of benefits have been taxable, when beneficiaries’ MAGI exceeds $34,000 for single filers and $44,000 for married couples filing jointly. The revenue raised from the inclusion of the additional 35 percent of benefits is credited to the Hospital Insurance (Medicare Part A) trust fund.

Neither the 50 percent nor the 85 percent MAGI thresholds are indexed for inflation. This feature will make a larger and larger share of the benefits taxable merely due to the effects of inflation.

Tax treatment of Social Security benefits also varies by state. Of the 41 states that have a broad-based personal income tax, 13 tax Social Security retirement benefits. If a state’s tax system is tied to the federal income tax, as is often the case, any additional federal taxation of Social Security benefits automatically translates into an additional state tax burden for individuals as well.

Taxing Social Security Benefits: Policy

Taxing Social Security benefits

No further action should be taken to increase the taxation of Social Security benefits. Any proposal to eliminate the second-tier level for taxing Social Security benefits should also permanently restore any lost revenue to Medicare to keep the Hospital Insurance trust fund whole.

Social Security cash benefits should be exempt from state income tax, at least to the extent that they are exempt under the federal income tax.

Tax-exempt interest

In this policy: FederalTaxationSocial Security benefits

Tax-exempt interest should not be taken into account in determining the amount of taxable Social Security benefits.