Americans rely on their Social Security benefits to cover a big portion of their expenses in retirement. Yet even though people have payroll taxes withheld from their paychecks throughout their careers to pay for Social Security, some retirees then have to turn around and pay federal income taxes on their benefits.
Adding insult to injury, a handful of state government tack on their own state income taxes on Social Security. Currently, 13 states take their share from monthly checks, but fortunately for taxpayers in one of those states, Social Security taxation is about to become a thing of the past.
Where you'll pay state income tax on Social Security currently
There's no rhyme or reason in which states impose income taxes on Social Security and which don't. Neighboring states often have different rules, and you'll find some of these 13 states in just about every area of the country.
The 13 states currently imposing Social Security taxes include:
- New Mexico
- North Dakota
- Rhode Island
- West Virginia
Now keep in mind that not all of these 13 states tax Social Security in exactly the same way. Some charge tax only on the income on which federal tax rules impose income tax, which means that many residents get away without paying anything. Other jurisdictions have specific exemption amounts that help residents avoid tax on at least a portion of their benefits, while others set income limits that differ from federal law.
Who's coming off the list?
Yet there's been some backlash against state income taxes on Social Security, stemming largely from the fact that retirees often leave a state if it costs them money to get their retirement benefits there. States don't want to take the economic hit that results when relatively wealthy retirees go to tax-friendlier states to spend their golden years. That's driven some tax reform efforts.
In particular, West Virginia is looking at eliminating its state income tax on Social Security benefits. Back in March, Gov. Jim Justice signed a bill that began to phase in tax-free treatment for Social Security benefits in calculating how much personal income tax a West Virginia resident owes.
Prior to the bill becoming law, residents paid tax on the same income that was included under federal law. That'll still be the case on 2019 tax returns. But when they file their 2020 state tax returns, West Virginia taxpayers will be able to exclude 35% of their Social Security benefits from their taxable income for state purposes. For the 2021 tax year, that amount goes up to 65% of the benefits they receive from Social Security. By 2022, 100% of Social Security benefits will be free of tax.
Be smart about taxes
Taxes on Social Security aren't the only factor in deciding where you want to spend your retired years. For one thing, many locations that have low income taxes have higher property or sales taxes. You have to look closely at your own financial situation to decide which place would be the best to live from a financial perspective. Even then, plenty of non-financial issues can take precedence.
Nevertheless, for those who live in West Virginia -- or who want to live there once they retire -- the state legislature's move to eliminate Social Security taxation by 2022 comes as welcome news. Many residents in the dozen states that'll be left will undoubtedly want to look at similar measures in the near future -- especially if the West Virginia experiment works well and leads to greater economic prosperity for the Mountaineer State on the whole.