When you retire, you may have to pay federal income tax on some of your Social Security benefits. The IRS uses a calculation known as your "combined income," which determines whether your Social Security benefits are taxable or not, and if so, how much. You can read a thorough discussion of Social Security benefit taxation on the federal level here.
In addition to the possibility of federal taxes, there are 13 U.S. states that also tax Social Security benefits. Some use the same methodology as the IRS, while other states have their own exemptions, credits, and other rules. Here are the 13 states that currently tax Social Security benefits, and some details about how it's done in each.
If you're under 65, up to $20,000 in Social Security benefits and other retirement income can be excluded from taxation. Once you're 65 and over, the exclusion jumps to $24,000. Despite the fact that it taxes Social Security benefits, Colorado is considered to be a rather tax-friendly state for retirees with a low state income tax rate and a generous homestead exemption for older homeowners.
In Connecticut, Social Security income is tax-exempt if your adjusted gross income (AGI) is less than $50,000 (individual) or $60,000 (married, filing jointly). When combined with some of the highest property taxes in the nation, and a lack of exemptions for pensions or other retirement income, Connecticut is one of the least tax-friendly states for retirees.
In Kansas, Social Security benefits are exempt for residents with AGI of $75,000 or less. In-state and military pensions are tax-exempt, and the state income taxes were recently reduced to a top rate of 3.9%, which goes into effect in 2018.
Minnesota taxes Social Security benefits in the same way the federal government does. Income tax and sales tax rates are rather high, and most pensions are taxable. Because of these factors, Minnesota is considered to be one of the worst states for retirees in terms of taxation.
Missouri taxes Social Security benefits, but only for higher-income retirees, defined as those with AGI of $85,000 or more (individual) or $100,000 (married). Taxpayers above these thresholds may even qualify for a partial exemption, so while Missouri does have a tax on Social Security benefits, it doesn't affect many retirees.
Although the taxable amount may vary slightly from the federally taxable amount, Montana does tax Social Security benefits. Additionally, Montana's top state income tax rate is 6.9%, but the state doesn't have a sales tax, which helps to offset these other taxes.
Social Security benefits are tax-exempt in Nebraska for taxpayers with AGI less than $43,000 (single) or $58,000 (married). In addition, sales taxes are close to 7% on average, and the top income tax bracket is 6.84%.
8. New Mexico
New Mexico allows for a retirement income exemption of up to $8,000 per person, which can include Social Security benefits. Beyond this exemption, Social Security benefits are taxable. However, New Mexico's income tax rates are toward the lower end of the states on this list.
9. North Dakota
North Dakota taxes Social Security benefits in the same way the federal government does, and offers no other tax breaks for retirement income. However, the income tax range of 1.1% to 2.9% is rather low, and seniors might qualify for a homestead exemption on their property taxes.
10. Rhode Island
Rhode Island taxes Social Security benefits, but only for taxpayers with AGI above $80,000 (individual) or $100,000 (married). There's also a new state income tax exemption starting in 2017 that excludes up to $15,000 in income for retirees, subject to income limitations.
Social Security benefits are taxable in Utah, but retirees 65 and older may be able to take advantage of a $450-per-person retirement-income tax credit (up to $288 for retirees under 65). At 5.95% and 5%, respectively, Utah's sales and income taxes aren't exactly on the low end, however.
Vermont taxes Social Security benefits in the same way the federal government does, and has a rather high top state income tax rate of 8.95%. The state also has a sales tax of 6% and some of the highest property taxes in the United States.
13. West Virginia
West Virginia taxes Social Security benefits in the same way the federal government does. However, taxpayers 65 and older can exclude the first $8,000 of any kind of retirement income per person (including Social Security and out-of-state pensions). West Virginia also has relatively low property taxes, as well as a homestead exemption for seniors.