Social Security has three sources of funding. The biggest is the payroll taxes workers pay on their incomes each year. That brought in over $1.1 trillion in 2022, the most recent year data is available. The interest on invested trust fund asset reserves added another $66.4 billion in income.
The remaining $48.6 billion -- a mere 4% of Social Security's total income -- came from taxing the benefits of seniors whose income exceeded certain limits. But that figure is expected to be higher this tax season. Here's why, and how much you might owe in benefit taxes.
Image source: Getty Images.
How the federal government taxes Social Security benefits
The federal government began taxing the Social Security benefits of select seniors in 1984, and 10 years later it altered its taxation rules to bring even more revenue to the program. Today, beneficiaries can expect the following portion of their benefits to be taxable if their provisional income -- adjusted gross income (AGI) plus nontaxable interest and half their annual Social Security benefit -- exceeds the following thresholds for their marital status.
|
Marital Status |
0% of Benefits Taxable |
Up to 50% of Benefits Taxable |
Up to 85% of Benefits Taxable |
|---|---|---|---|
|
Single |
Provisional incomes under $25,000 |
Provisional incomes between $25,000 and $34,000 |
Provisional incomes greater than $34,000 |
|
Married |
Provisional incomes under $32,000 |
Provisional incomes between $32,000 and $44,000 |
Provisional incomes greater than $44,000 |
Data source: Social Security Administration.
It can look alarming at first, but it's not as bad as you might think. Even if you fall into the 85% taxable bracket, that doesn't mean you'll give 85% of your benefits back to Uncle Sam. It means you'll pay ordinary income tax on 85% of your benefits. Income tax brackets range from 10% to 37%, and most people fall toward the lower end of this range.
The above taxation rules haven't changed since 1994, but the same can't be said for provisional incomes. Inflation continues to drive up the cost of living, which means seniors have to spend more to maintain their lifestyles, and that can result in higher AGIs (through more retirement withdrawals or earning more income). Social Security benefits also continue to trend upward over time, thanks in part to cost-of-living adjustments (COLAs) in most years. Together, these factors lead to more seniors encountering these benefit taxes each year.
It's not just the federal government that taxes Social Security
Currently, 10 states also tax the Social Security benefits of some of their seniors:
- Colorado
- Connecticut
- Kansas
- Minnesota
- Montana
- New Mexico
- Rhode Island
- Utah
- Vermont
- West Virginia
Also, if you live in Missouri or Nebraska, you may have to pay benefit taxes when you file your 2023 returns. These states just suspended their benefit taxes at the start of 2024.
Not all seniors who reside in one of these states pay these taxes. Each has its own formula for determining who owes them. For example, Connecticut residents only pay taxes if their AGI is $75,000 or more for single filers or married couples filing separately or $100,000 or more for married couples filing jointly. Check with your state department of taxation or a tax professional in your area to learn how it handles Social Security benefit taxes and whether you could owe them.
How to prepare for Social Security benefit taxes
The above table can help you estimate your Social Security benefit taxes. If you run into these, it could result in a smaller refund or possibly even a tax bill this year. Should you owe the IRS, you can set up a payment plan if you don't have the cash to pay it upfront. When in doubt, consult a tax professional to decide upon the best approach.
For future years, you might be able to reduce your odds of owing Social Security benefit taxes by reducing your spending or relying more upon Roth savings. These accounts are funded with after-tax dollars, so they don't count toward your taxable income for the year. But this isn't always feasible.
You can also request that the government withhold money from your Social Security checks for taxes if you'd like. This will shrink your monthly checks, but it can also help you avoid a surprise bill when you file your returns. Consider all your options before deciding on the approach that works best for you.
