For most seniors, Social Security is an indispensable financial lifeline. More than two decades of surveys from national pollster Gallup show that between 80% and 90% of current retirees lean on their payout to cover at least some portion of their monthly expenses. Meanwhile, data from the Center on Budget and Policy Priorities finds that no program lifts more people above the federal poverty line than Social Security.
But just because Social Security is vital to the financial well-being of tens of millions of current retirees, it doesn't mean there isn't controversy surrounding how the program is funded.
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There's no aspect of Social Security that retirees loathe more than the taxation of benefits. In July, an informal poll from senior advocacy group The Senior Citizens League found that an overwhelming 94% of respondents believe Social Security benefits shouldn't be taxed.
The hatred of this tax comes from the belief that taxing Social Security benefits is a form of double taxation. The idea being that earned income (wages and salary, but not investment income) is taxed during a workers' time in the labor force, and is then being taxed again vis-à-vis their Social Security payout during retirement.
Are Social Security benefits being double-taxed? The answer is a very surprising yes and no, depending on how much you earn and where you live.
The ins and outs of how Social Security generates revenue
While I'm going to directly address in what instances double taxation does and doesn't take place with regard to Social Security income, we first have to examine how Social Security is funded. This knowledge is paramount to understanding why certain situations are or aren't examples of Social Security double taxation.
In 2022, the Social Security program brought in about $1.22 trillion in revenue from three separate funding sources:
- Payroll tax ($1.11 trillion)
- Net interest ($66.4 billion)
- Taxation of benefits ($48.6 billion)
The 12.4% payroll tax is applicable to all earned income between $0.01 and $160,200 (as of 2023). This range means 94% of workers are paying into Social Security on every dollar they earn. Taxing wages and salaries consistently accounts for around 90% of the money Social Security collects.
The $66.4 billion in net interest pertains to the interest the program earns on special-issue bonds and certificates of indebtedness. Since inception, Social Security's asset reserves have grown to more than $2.8 trillion. By law, this excess capital is required to be invested in interest-bearing special-issue bonds.
The third funding source is the aforementioned taxation of benefits. With the program's asset reserves running on fumes in 1983, Congress passed and President Ronald Reagan signed the Amendments of 1983 into law. Among other things, this sweeping overhaul allowed up to 50% of an individual's Social Security benefit to be exposed to federal ordinary income tax rates if their provisional income topped $25,000 (or $32,000 for married couples filing jointly).
In 1993, the Clinton administration added a second tier of taxation that exposed up to 85% of benefits to federal taxation for single filers and couples whose provisional income topped $34,000 and $44,000, respectively. The income thresholds associated with the taxation of benefits have never been adjusted for inflation. Over time, more seniors are being exposed to this tax.
Are Social Security benefits double-taxed?
Now that you have a better understanding of how Social Security is funded, let's get back to the core question at hand: Is taxing Social Security benefits a form of double taxation?
For most Social Security beneficiaries, the answer is no.
According to the Social Security Administration, 56% of beneficiaries will owe some level of tax on the benefits they receive. This means 44% of beneficiaries won't be taxed on their payout.
For the 56% who are paying tax on their benefits, you're not receiving the same dollar you paid into the program. The funds being collected via the payroll tax from today's working Americans are being doled out to current retirees. When today's workers retire in the years and decades that lie ahead, the payroll tax dollars of new generations of workers will be responsible for funding Social Security benefits. Since you're not getting back the same dollar you were initially taxed on, it's not being double-taxed.
To add, there's absolutely no way to specifically trace the origin of the Social Security dollars you're receiving. They could come from recurring sources, such as the payroll tax and taxation of benefits, or a nonrecurring source, such as the interest income on the program's asset reserves. The latter doesn't derive from taxation.
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Residents in 12 states can face double taxation on their Social Security benefits
However, the double-taxation of Social Security benefits can occur at the state level.
A grand total of 38 states don't tax Social Security benefits. But if you live in one of the 12 states that do tax Social Security benefits, and earn above the preset income thresholds in those states, double taxation can occur. You'd be paying tax on the very same Social Security dollar at the federal level and state level.
The 12 states that currently tax Social Security benefits above certain adjusted gross income (AGI) thresholds are:
- Colorado
- Connecticut
- Kansas
- Minnesota
- Missouri
- Montana
- Nebraska
- New Mexico
- Rhode Island
- Utah
- Vermont
- West Virginia
The good news if you live in these states is that the income thresholds are relatively high -- often between $45,000 and $85,000 in AGI for a single filer -- or have been climbing in recent years.
For instance, Minnesota, North Dakota, Vermont and West Virginia, mirrored the federal taxation of Social Security benefits as recently as 2016. Since then, North Dakota has eliminated the taxation of Social Security benefits, while states like West Virginia have increased the individual and married filing jointly AGI thresholds to $50,000 and $100,000, respectively.
Unless you're generating a meaningful amount of income in one of these 12 states, you're not being double-taxed on your Social Security benefit.
